Invoice factoring and invoice discounting are invoice-based financing options. Since they provide finance against unpaid invoices, people often confuse the two.
Invoice financing is used by businesses to generate revenue from their outstanding invoices. The funder can be a bank or other financing company that provides loans against outstanding debtors. The financing company charges a fee for providing upfront cash to the business. Two main types of invoice financing are invoice factoring and invoice discounting. Both result in cash inflow in the organisation. It boosts the working capital requirements of the company.
Invoice factoring is a type of financing facility in which the company sells some of its outstanding invoices to the factoring company. The factoring company, in turn, pays around 80-90% of the invoice amount immediately. The rest is paid when customers make the actual payment to the factoring company. The factoring company will deduct its fee when making the balance payment. It helps to resolve the cash crunch faced by small companies.
Additionally, the factoring company provides value-added services of collecting payments from customers and sales ledger management. This facility saves a lot of time and avoids hassle. But one disadvantage is that the customers are aware of this facility, which may negatively impact them as they may think that your company is facing cash flow problems.
Invoice discounting is a type of financing facility. The discounting company gives a loan to the business at a certain percentage of the amount outstanding in the accounts receivable ledger. The ledger consists of credit sales on which the dues are yet to be paid by your customers. Once the business receives the payment from the customers, it will repay the loan amount along with the fee charged for such a discounting facility. The fee is usually charged at 1%-3% of the total invoice value.
Here, the invoice collection responsibility is undertaken by the business itself, enabling them to control their customer relationships. It is a good option if one is looking to build long-term customer relationships. The government has built an invoice discounting marketplace such as TReDs to ensure benefits are extended to wider markets. MSMEs and companies with no collateral can derive maximum benefits from this programme.
Some of the differences between invoice factoring and invoice discounting are discussed below:
|Particulars||Invoice factoring||Invoice discounting|
|Meaning||It is a type of financing in which some outstanding invoices are sold to the factoring company.||It is a type of financing in which the discounting company lends a certain percentage of the amount outstanding in the receivables ledger.|
|Used by||Smaller companies use this facility.||Bigger companies use this facility.|
|Responsibility||Factoring company is responsible for the collection of invoices.||The business is responsible for the collection of its invoices.|
|Right over the invoice||Factoring company has exclusive rights over the submitted invoices.||Discounting company just provides a loan against the outstanding invoices. It does not have any control over the submitted invoices.|
|Customer awareness||The customer is aware of the factoring facility used by the business.||The customer is not aware that the invoices are discounted.|
|Cost||It is more expensive because you are provided with a value-added service of maintaining a full sales ledger and invoice collection.||It is less expensive as no add on services are provided under such type of financing.|
|Payment||The customer makes the payment of the invoice to the factoring company.||The customer makes the payment of the invoice to the vendor company directly.|