Invoice Factoring vs Invoice Discounting: What's the Difference?

Invoice Factoring vs Invoice Discounting at a glance

Both Invoice factoring and Invoice Discounting are ways to improve cashflow by releasing the funds that are tied up in your outstanding invoices. They both provide access to working capital, but the way in which you manage your customers' payments and credit control are different. 

The table below sets out the key differences between Invoice Factoring and Invoice Discounting to assist you in determining which is the right option for your business.

The main difference: who controls your sales ledger?

The main difference between Invoice Factoring and Invoice Discounting lies in who is responsible for managing your sales ledger and collecting the payments.

In the case of Invoice Factoring, the finance company usually takes over the responsibility for credit control, following up with customers on your behalf. With Invoice Discounting, your business continues to hold these responsibilities and maintains control of collections.

Both solutions provide access to working capital, but the choice comes down to whether you want to outsource credit control or keep it in-house.

How credit control works with Invoice Factoring

When you're using Invoice Factoring you carry on issuing invoices as usual, while the finance company takes charge of the collection process. This can reduce the administrative burden on your team by outsourcing the collection of payments. It could be beneficial if you have limited internal resources or if you want to reduce time chasing late payments.

How credit control works with Invoice Discounting

With Invoice Discounting, you issue your invoices as usual and collect payment yourself. It enables your business to maintain direct control over customer payments and communications, which may be more appropriate for companies that have established credit control procedures.

Will your customers know you're using Invoice Finance?

Whether the customer is aware you're using Invoice Finance will depend on the arrangement.

Invoice Factoring is frequently disclosed, so the customer knows that a finance provider is handling the collection of their invoices. There are, however, some providers who will offer factoring on a confidential basis, where credit control can be undertaken without the customer necessarily being aware of the factoring arrangement.

Invoice Discounting is almost always a confidential arrangement. Your business will continue to handle payment collections and customer communications so in most cases the customer will not be aware that you're using Invoice Finance.

If confidentiality is important then it's worth discussing the options with your provider, rather than assuming one product is automatically more suitable.

Which requires more internal finance resource?

Invoice Discounting generally requires more in-house finance resources as your business remains responsible for the management of the outstanding invoices and the collection of the payments. You're going to need the staff, the systems and the processes to be able to track payment due dates and follow up on overdue invoices.

Invoice Factoring takes on much of the credit control burden so that the business itself is not responsible for it. For a company with a small finance team this can be a very effective way of freeing up time for other things without the need to grow its in-house collections team.

The best option may depend on whether your current team have the capacity to handle credit control.

How do eligibility requirements differ?

Both products are typically aimed at businesses that invoice other businesses, though the providers may have slightly different criteria when assessing eligibility on a facility by facility basis.

Invoice Factoring can be a more viable option for smaller businesses or those that are growing and don't have an established credit control team in place, as the finance provider takes on the responsibility of chasing the invoices.

Invoice Discounting generally requires the business to have a track record of good financial management, a solid accounting system and a proven ability to collect from customers. Some providers will also have higher minimum turnover requirements.

Suitability will ultimately be subject to agreement with provider, where considerations such as the business's financial position and its debtors will be taken into account.

How do the costs compare?

Both solutions will normally involve a service fee and a funding charge (the precise structure and amount of both of these will vary from provider to provider).

Invoice Factoring fees will reflect both the funding facility and the outsourced credit control service. Invoice Discounting may have lower service fees as the collections are in-house, although you do have to factor in the cost of your own credit control team.

Optional services (e.g. bad debt protection) can also be part of the cost considerations for either arrangement. The protection would be available to cover qualifying losses due to customer non-payment, subject to the terms and conditions and limits agreed.

Neither option is automatically the cheaper one. The best way to compare them is to look at the total cost of the facility and the internal resources and services that would be required.

Which may suit a smaller or growing business?

Smaller or growing businesses will naturally have very limited time and resources to devote to credit control, especially as the volume of invoices increases.

Invoice Factoring may be the better solution in those circumstances, as it provides access to working capital and removes the time spent on monitoring and chasing payments. It enables a smaller finance team to focus on other areas of the business without having to take on the additional burden of credit control.

A smaller business with good financial systems and a well-established collection process could still be suitable for Invoice Discounting. 

Which may suit an established business with its own credit control team?

Businesses that have in-house finance teams and well established collection processes may find Invoice Discounting the more appropriate route.

It enables them to retain control of customer payments and relationships whilst having access to finance against the outstanding invoices. This can be a very useful proposition in the case of a business that already has a good accounting systems and routines and a good understanding of its customers' payment behaviour.

However, larger businesses may still opt for Invoice Factoring if it enables them to reduce their administrative burden or to outsource their collections. Size of business in itself doesn't dictate which should be the preferred option.

Can a business move from Invoice Factoring to Invoice Discounting?

Yes, subject to agreement with the provider, businesses can move from Invoice Factoring to Invoice Discounting as their business develops (or from Invoice Discouting to Invoice Factoring, for example, if support with credit control is needed to help with slow paying customers)

Invoice Factoring vs Invoice Discounting: example business scenarios

Below are two scenarios to illustrate the practical differences between Invoice Factoring and Invoice Discounting....

Scenario 1: recruitment agency without a dedicated credit control team

A growing recruitment agency provides temporary staff to a number of business clients. They have to pay their workers each week, but their clients typically pay their invoices on 30 or 60 day terms so there's a gap between the money going out and the money coming in.

They already have a very small finance team looking after payroll and invoicing so chasing up payments is an additional pressure point.

Invoice factoring could be the answer. The agency could factor its invoices (with the provider taking over credit control) and access funding against the invoices. This would help with the management of payroll and free up considerable time that would otherwise be spent chasing payments.

Scenario 2: established manufacturer with an experienced finance team

An established manufacturer supplies to commercial customers (many of whom pay on credit terms). Sales are good, but the business would like to make use of the funds currently tied up in the outstanding invoices so that it can go out and buy materials and invest in equipment.

The manufacturer already has an experienced finance team looking after the sales ledger and customer collections.

Invoice Discounting could be the answer. The business would be able to get the finance it needs whilst retaining its existing credit control processes and communication with its customers.

Questions to ask when choosing between Invoice Factoring and Invoice Discounting

When deciding between Invoice Factoring and Invoice Discounting, think about how each one would work within your current business processes and how it could meet your future requirements.

• Who should be in charge of credit control? Would it be best to outsource the collections function or would you rather keep it in-house?
• How important is confidentiality?

Neither solution is superior. Both can improve access to working capital but Invoice Factoring is generally the better option if your business would benefit from support with credit control, Invoice Discounting could be the better option if you to retain control over collecting customer payment.

For more on the individual solutions, take a look at our invoice factoring and invoice discounting pages, or read more about how invoice factoring works.