Invoice Factoring vs Invoice Discounting: Pros and Cons

Invoice Factoring vs Invoice Discounting: Pros and Cons

Invoice financing is a way of borrowing against a company’s debt. Factoring and invoice discounting are two different types of invoice financing, and each has its advantages and disadvantages. Certain industries favor these types of financing, including construction, wholesaling, logistics, printing, and recruitment. Many of these businesses invoice from 30-90 days or have cash flow vulnerabilities because they have higher value invoices and fewer customers. Exploring the differences can help identify what type is best for the business at hand.

One of the best things about factoring is that the third party or factor is tasked with chasing payments, maintaining the sales ledger, and managing the credit control process. In addition, the third party may be able to help negotiate with suppliers for better terms. 

Working with a third party, in this case, means that the customers do not deal with the business directly, and that could be a disadvantage if they prefer directness. It also means that services provided by the factor come at a price that is typically about one or two percent of turnovers. Unfortunately, if the customer has a poor experience with the third party, it can leave a bad impression on the business. 

In contrast, invoice discounting involves the business directly interacting with customers through debt collection and credit control of the accounts. Any impression made by customers can be, at least in part, controlled by the business. This closer relationship can help build and maintain strong working relationships with consumers. The existence of the third party in the relationship can be kept confidential if the business leaders choose.

Invoice discounting is not available for all businesses because lenders prefer that the company have a positive net worth and a higher turnover. In-house, strong, and established credit collection processes are also preferable by lenders. Business owners can find themselves with a negative impact on operation and sales and are unable to leave the arrangement if they depend on this type of financing as a source of cash.

Assessing the pros and cons of these two types of invoice financing can be helpful. Ultimately, the most important advantages are the ones that benefit the business the most. Having another company handle some of the financial aspects can be significant, particularly for those who have struggled with those processes. Larger businesses and those with accepted and demonstrated processes may benefit more from keeping them in-house. A close look at business operations may shed light on the best type for the company.