How Invoice Discounting and Invoice Factoring Works

August 18, 2022
the INFT team

Capital injections allow a company to grow, expand, refinance, or stabilise. Sometimes, a country's government will step in to help the country's industry to stabilise or grow. Suffice to say, it doesn't happen very often and does not apply to all industries and companies. That's when corporations would need capital injections or apply for business loans in order to strive towards their next goals. 

If your business needs more financial flexibility, invoice factoring or invoice discounting could be the SME financial facility you’re looking for. 

Most people do not know the difference between invoice discounting and invoice factoring. So, we’re here to break it down and help you understand the difference. Most importantly, you will have a clearer picture about how it will affect your business. 

What is Invoice Financing - In the Nutshell

As with most businesses, we give our customers credit or repayment terms. It depends on what you're comfortable with. Most of the time, companies give their customers 30, 60, or 180 days to pay their invoices.

This means they can purchase something from you today and pay for it when the payment is due. 

Invoice financing is a way to get a financial institution to monetise your company’s outstanding invoices, i.e. AR, account receivable. The financial institution will pay you upfront a percentage of the invoice amount minus the fee for the facility. Invoice financing is a useful financial short-term facility that allows you to get a quick cash injection immediately instead of waiting for your customers to pay you. 

While invoice factoring and invoice discounting are similar, there are some small differences consumers should know about before signing on the dotted line. 

What is Invoice Factoring?

In short, invoice factoring for small businesses is a financial facility that enables you to ‘sell off’ your unpaid invoices to a third party financial institution at a discounted rate. When you ‘factor’ the invoices you’ve issued to your customers, the financial institution will pay you a percentage of the invoice and take over the invoices. Collection will be done by the financial institution.

This means, from the point the invoices are financed, your customers will be dealing with the third party. 

Most businesses factor in their invoices to get quick access to cash instead of waiting out the payment term period after goods and services are rendered or delivered. 

With the immediate cash, the company can then re-invest the cash right away or use it to mobilise projects, etc. 

What is Invoice Discounting?

Invoice discounting works pretty much the same way invoice factoring does. The main difference is confidentiality. That is why it is sometimes referred to as confidential invoice discounting

When you use invoice discounting, you will continue to deal with your customers yourself as usual. Your customers do not have to know that you’re financing your business using invoice discounting. 

It also means you need to track down repayments yourself without the bank’s help. Defaults or delays in payment would continue to be shouldered by your business. 

how invoice factoring & invoice discount works

Which One Is Better For Your Business? Invoice Discounting or Invoice Factoring

As you can see, both invoice factoring and invoice discounting are similar. It’s a means where you sell your unpaid invoices to a financial institution to get advance payment

Here’s the main difference: when you use invoice discounting, it's a bank loan secured against your outstanding invoices. If there are defaults and delays, you would either have to request for repayment, or repay the bank yourself. When you use invoice factoring, the financial institution has purchased the unpaid invoices outright. 

With invoice factoring, the financial institution will then deal directly with your customers, potentially affecting your working relationship with your customers. The financial institution has a team of credit control officers who will take over tracking of repayments.  

On one hand, you no longer need to worry about delayed payments. But on the other hand, things will be different if the financial institution decides to take drastic measures. If your customers fail to repay the invoices, you won’t be obligated to pay the money advanced to you yourself. This means it could be non-recourse

Invoice discounting is a loan, not a sale of the invoice. If the repayment is not met, you have to repay the amount yourself. 

How Invoice Discounting and Invoice Factoring Benefit Small Businesses

Since most financial institutions who offer invoice discounting or invoice factoring facilities do not require anything more than proof of the invoices and sale, it is one of the easiest ways for small businesses to obtain advance cash to improve their cash flow

It also does not require any form of collateral. 

However, since invoice factoring and invoice discounting are pretty risky businesses for the lender, they may run checks on your customers before agreeing to provide you with the loan. Especially if you’re applying for the non-recourse invoice factoring

The financial institution would need to know the creditworthiness of your customers before agreeing to the facility. 

Of course, since invoice discounting and invoice factoring does not need collateral, it protects your assets from a debt trap. These quick injections of funds means you’re also getting cash in advance without having to wait for payment yourself. 

Just as a reference, invoice factoring is most likely used by smaller companies because of its accessibility. Bigger companies with a steady stream of customers and reliable customer base may opt for invoice discounting because it gives them the privilege of anonymity. 

Before you go…

Most companies, big or small alike, need funding or a business loan to expand their businesses, launch new products or services, hire new talents, or reach new markets. The most obvious thing to do for the company is to raise funds either via investments, using their profits, launch a crowdfunding campaign, or obtain a business loan.

And if this is what you’re doing for your business, INFT is ready to help you realise your goals. 

Sign up for a free business account with us today and get in touch with us if you are interested in our Cashline. 

And don’t forget to either follow us on our social media accounts or sign up for our newsletter via the form below. 

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