Factoring and invoice discounting are financial services offered to businesses usually by a third party (like a bank) to help them improve their cash flow.
Let us first look at some definitions:
- Factoring: Selling your outstanding invoices to a third party, they will process the invoices for you and loan you part of the value of the outstanding invoices. They are essentially providing a debt factoring collection and ledger management service.
- Invoice discounting: works slightly differently. You still borrow money against your invoices however your business still retains control over the administration of your sales ledger. This means that your customers will never know that you are using the service as you are still responsible for collecting the debts.
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Why use factoring?
Using factoring can have many benefits especially for small businesses as it can free up cash when they need it most. By using factoring a business does not have to wait for their customers to pay and can collect most of the value of the invoice immediately.
Using factoring can save a business a lot of man hours because the factoring company takes responsibility for collecting and chasing the debt allowing the business to concentrate on their core business activity.
With small businesses in particular, cash flow can make the difference between profit and bankruptcy and so when used properly factoring can offer a valuable lifeline to small businesses.
Why use invoice discounting?
This is when you are lent you most of the value of your invoices, a process quite similar to factoring, but you take responsibility for collecting the debts.
This service is cheaper and has the advantage of your customers not knowing that you are using the service.
This can be particularly useful if personal relationships with your customers are important and you don’t want an outside company to deal directly with them.
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