Invoice Discounting vs. Factoring: What’s the Difference?

Written By
G. Dautovic
Updated
December 15,2022

Understanding how invoices work is an important part of running any business. When you’re waiting to be paid for the work you’ve already delivered to a client, it can affect your credit control and stunt your ability to grow your company. 

The differences between invoice discounting and invoice factoring might seem confusing at first, but our article will explain what these differences are. When deciding between invoice discounting vs. factoring, which one makes the best invoice finance strategy for your business? Read on to find out!

What Is Invoice Discounting?

Invoice discounting is common among small businesses, as it helps them free up capital they can then use to invest in their growth or manage cash flow. Invoice discounting, in its essence, is a loan that is secured against outstanding invoices. It allows small to medium-sized businesses (SMBs) to maintain better control over their accounts receivable and customer relationships.

The discounted amount that the company receives is usually less than the full face value of the invoices, allowing them to receive cash more quickly instead of waiting for the normal amount of time it would take to collect the invoice.

In this case, businesses benefit from the discounting of invoices because it provides fast access to funds without compromising business resources or customer relationships. This makes it a reliable service for businesses that struggle with credit monitoring or need extra capital during slow times. 

Additionally, invoice discounting often provides businesses with more flexible terms than a traditional bank loan.

Invoice discounting is a valuable form of financing for businesses that need quick cash but cannot access more traditional forms of loan capital or lack the credit rating necessary for traditional funding routes. 

It’s used to secure additional funding in the event of cash flow issues, allowing businesses to focus on running their operations and servicing their customers without worrying about money.

What Is Invoice Factoring?

Invoice factoring, similarly, is a financial solution that allows businesses to unlock cash they’ve earned from their customers’ outstanding invoices. However, the distinct difference with invoice factoring is that it’s done by selling the invoices to a third-party invoice factoring company. 

Right away, the business receives an advance on the money they’re owed, allowing them to cover their immediate expenses and maintain better credit control, while the invoice factoring company receives payment directly from the business’ customers.

Invoice factoring is an important financial tool for businesses as it speeds up the process of assessing working capital quicker than would otherwise be possible. 

This approach allows the business to make necessary purchases, hire workers, or pay the bills without having to wait for customers to settle their accounts. Additionally, it helps businesses of all sizes manage cash flow efficiently while ensuring they don’t miss key opportunities due to not having access to their funds.

Key Differences

Invoice factoring and invoice discounting are two common invoice financing practices used by businesses that help manage cash flow in different ways. 

Invoice factoring involves the sale of invoices at a discounted rate directly to a third party, or factor, so that the business can receive its payment immediately, rather than waiting for their customers to pay.

On the other hand, the discounting of invoices is an arrangement between a business and its bank that allows the business to borrow based on its current outstanding invoices, which remain with the business until payment from customers is received by accounts receivable. 

Unlike invoice factoring, where clients are typically required to disclose this information to their customers, invoice discounting does not directly involve customers, so disclosure is not necessary.

Both invoice financing strategies serve as valuable financial tools for businesses needing access to short-term liquidity. The key difference between the two lies in who is taking on the risk associated with collecting payment from your customers.

With invoice factoring, an invoice finance firm, known as a “factor,” purchases your outstanding invoices, taking full responsibility for recovering payments from your customers. In contrast, with invoice discounting, your accounts receivable department remains responsible for collecting payments but has access to extra funds in exchange for a financial discount.

Final Thoughts

At the end of the day, both invoicing strategies serve as essential financial tools for businesses needing access to short-term liquidity. They are both good invoice financing options for your business, and now you know exactly how they work. 

In the event you choose invoice factoring, make sure you elect a reliable invoice financing company so you can create the right invoice financing strategy and keep credit control over your business. 

Now that you understand invoice discounting vs. factoring, nothing is stopping you from creating an invoice finance strategy that is perfect for your business.

FAQ

What is invoice factoring?

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Invoice factoring is a financial tool that allows businesses to sell their customer invoices at a discounted rate to a third-party invoice finance firm. In exchange, the company receives payments more quickly, while the invoice finance firm collects payment directly from the business’ debtors.

What are the best invoice factoring companies?

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The right invoice factoring company for your business will certainly depend on your specific needs. Types of products or services your business offers, how much money you need to borrow, and speed of accessing the funds should all be taken into serious consideration when choosing a professional invoice factoring service.

About author

I have always thought of myself as a writer, but I began my career as a data operator with a large fintech firm. This position proved invaluable for learning how banks and other financial institutions operate. Daily correspondence with banking experts gave me insight into the systems and policies that power the economy. When I got the chance to translate my experience into words, I gladly joined the smart, enthusiastic Fortunly team.

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