Both invoice factoring and invoice discounting are ways to get financing fast to fill cash flow gaps so you can pay down immediate expenses like payroll, rent or utilities, and restock inventory when supplies are running low. One lets you retain ownership of the invoice while the other sells ownership to a factoring company (the company that purchases the unpaid invoice).
Knowing when to use which is a matter of the relationship you want with your customers, how much money your business needs now, and the amount of time you have to chase down customers that are always late in paying. First, let’s take a look at the differences between these two invoice financing options.
The Differences Between Invoice Factoring and Invoice Discounting
- Invoice factoring is where a company sells unpaid invoices to a factoring company who then collects the payments. The factoring company pays you a discounted rate from the invoice and will then begin contacting your customers as you no longer own the debt.
- Invoice discounting is when a company uses unpaid invoices as collateral for a short-term business loan and the company retains ownership of the invoice. The original business will be responsible for collecting payments from the customer and paying back the borrowed money plus interest to the creditor that loaned them the money.
Invoice factoring fees change depending on the company you sell the invoices too, but you can expect to lose between 1% and 5% of the invoice’s value instead of paying interest, compared to invoice discounting which can range from 1% to 2.5% but you have to do more work by collecting money from your customers and paying the borrowed money back.
The numbers may look similar, but they have different impacts on your business. Here’s how to choose between invoice discounting and invoice factoring when both seem like a good option.
When to Choose One Over the Other
Some situations make more sense for one over the other. It all comes down to the rate you get, as a 4% difference can be a substantial amount on larger deals when cash flow is tight, and the relationships you have with your customers.
Customer Relationships
Invoice discounting is better than invoice factoring when you have strong relationships with your customers and do not want to risk hurting the relationships. You’ll likely need to be friendly but stern when payments are late, and you maintain control of collecting payments with invoice discounting. If you sell the invoice via invoice factoring, you have no say in how the factoring company will treat your customer, and that could damage the relationship.
Short on Time and Business Is Good
Invoice factoring is better than invoice discounting when you are short on time and have plenty of active customers, as factoring lets you sell the invoice so you can still make money, and you don’t have to spend time following up with customers to get paid.
When you have multiple customers and can afford to lose one or two, you won’t have to worry as much about the potential strain on certain customer relationships (i.e., if the invoice factoring company is too aggressive because demand for your company is strong). You can instead focus on running your business, not stressing over accounts receivable.
When You Have Time for Approvals
When you have a few days or a week before you need to increase cash flow, invoice discounting is a better option than invoice factoring as you can borrow the money via a short-term business loan like equipment financing or working capital loans. These can be used to cover payroll and operational expenses or repair and replace machinery, and you don’t have to risk your customer relationships in this scenario.
Having the extra time gives the lender a chance to review your application, and by getting financing with alternative lenders, you can normally receive an approval decision in as little as 24 hours.
This is where business loan marketplaces like us come in handy, as we know what lenders look for, their average approval times, interest rates, and all of the elements that go into decision making. Using our services takes the guesswork out of the process too, as we match you with your top financing options in seconds, saving you valuable time and eliminating a lot of potential paperwork. Click here and fill out our form if you’re interested in seeing your top options. There’s no commitment or risk.
SmallBusinessLoans does not provide tax, legal or accounting advice. This material has been prepared for informational purposes only. You should consult your own tax, legal and accounting advisors.
