Invoice discounting vs factoring
Finance for recruitment agencies

Invoice discounting vs factoring

Invoice finance Is a type of business funding where funds are accessed immediately from unpaid invoices. It is used to alleviate cash flow issues caused by payment terms on invoices, that is the time between delivering a product or service and receiving payment for it.

It is a short-term cash injection with the loan repaid when the client pays the invoices associated with it. Instead of waiting weeks or months for invoices to be paid, a lender advances the funds upfront. This gives the business quick access to cash, which can then be used as working capital for whatever they are required for; such as meeting payroll, taking on new orders, investing in equipment or machinery, or hiring staff. 

Introducing invoice discounting and factoring

Invoice finance, also known as accounts receivable finance is an umbrella term to describe monetising your company’s outstanding invoices, but there are two distinct forms of invoice financing; invoice factoring and invoice discounting. In this article, we will explain both and explore the differences and the advantages and disadvantages of each.

How does invoice finance work for business?

Example 1

A labour hire company supplies skilled workers to the construction industry. Their clients are large developers and they are sending as many as 20 workers to this company at any one time. The contractors are employed by the labour hire company and they are paid on a fortnightly basis. It is essential that these workers are paid accurately and on time every time. 

After paying the workers, an invoice for the payroll, plus fees is sent to the client. Their client has 30-day payment terms, meaning the labour hire company is out of pocket for that amount of time. 

With invoice finance - both factoring and discounting - they can get a large proportion of those funds upfront to ease the cash flow burden. This allows them to invest in other things, such as hiring more contractors and growing the business. 

Example 2

A manufacturing business obtains raw materials from overseas. They must pay for those, along with labour, rent, machinery, and all other overheads. To produce a finished product end-to-end takes weeks and upon delivery, they must wait a further 45 days for payment from the wholesaler.

The cash flow gap in this situation runs into months and would be unsustainable without invoice finance. With upfront funds, they can fulfil more orders and expand their business.

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Who uses invoice finance?

Invoice finance is typically used by those businesses that invoice upon delivery of a completed product or service. These invoices are seen as less of a risk than one which is project-based or involves milestone payments since the work has been delivered and the funds are owed. 

It is common in;

  • Manufacturing
  • Transport
  • Storage
  • Wholesale and distribution
  • Recruitment and staffing. It is particularly common in temporary and contract recruitment as the hours being invoiced have been worked and it is highly unlikely the invoice won’t be paid. These are also extremely cash-flow-intensive industries. 

What is invoice factoring?

With invoice factoring, the accounts receivable (the invoice ledger) are sold to the lender (otherwise known as the factor). The lender advances a high % of the total - as much as 95% - immediately. When the invoice is paid they remit the remaining balance, minus their fee. 

The invoice ledger is generally sold for one lump sum. As the invoices are now owned by the lender, they take responsibility for credit control and collections. The customer will now pay the finance company instead of the company they did business with. As such, the arrangement is made known to the customer. It is therefore a disclosed arrangement.

Who is invoice factoring for?

It is easier for smaller businesses to access factoring than discounting. As the lender takes over the collection process, the risk is lowered. It can also be beneficial for smaller companies as by selling their outstanding invoices, the admin of chasing payment is taken out of their hands. 

What is invoice discounting?

With invoice discounting, rather than selling invoices to a third party, a financier will lend a business a % of the value of their unpaid invoices. That loan is repaid when the invoice is paid. It works like an overdraft against the invoices with the amount available rising and falling as invoices are paid and raised. 

The business retains control of collections and the customer pays them as normal. Therefore invoice discounting  is often non-disclosed or confidential, meaning the customer is unaware that their invoices have been financed. 

Advance rates tend to be lower - usually around 80-85% - as it is a riskier proposition for the lender. It is available for more established businesses - compared to invoice factoring. To those with a more consistent customer base and a collection department. Facilities are often $100k+ - invoice factoring can be much smaller. 

Invoice discounting vs invoice factoring: the pros and cons

Invoice factoring

Table Example
Pros Cons
Greater accessibility - used by small businesses without collections departments Disclosed arrangement - allowing a third party to speak to customers could hurt relationships and reputation
Higher upfront payment - 95% Higher costs as credit control are included
Less time and effort required- no chasing or credit control
Less approval criteria  - with invoice discounting clients will be credit checked

Invoice discounting

Table Example
Pros Cons
Confidential - your clients won’t know about your need for financing Less accessibility - requires a track record of timely collection and usually a minimum turnover
Lower costs - it doesn’t include credit control Lower upfront - 85%
Works like an overdraft - you can use it again and again as you raise more invoices More time and effort required - will require a collections department 
Less approval criteria  - with invoice discounting clients will be credit checked

What are the main differences: Invoice factoring vs invoice discounting

So in summary the key differences between invoice discounting vs factoring are as follows:

Invoice discounting: a loan against invoices, where the business remains in control of collections. Often a confidential arrangement. 

Invoice factoring: where the invoices are sold outright to a lender who takes over collections. As such, it is a disclosed arrangement. 

Disclaimer: always refer to professional advice. The information presented here is purely indicative and not intended as advice. Always consult a legal or finance professional.

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