Difference Between Factoring and Invoice Discounting

Factoring vs Invoice Discounting
 

Factoring and invoice discounting are methods used by sellers of goods and services to obtain payment on their invoices and receivables through banks and financial institutions that offer factoring and invoice discounting services. Factoring and invoice discounting offer businesses an avenue in which to recover their tied up capital and improve cash flow. This article offers a clear explanation of each type of invoice finance and highlights the similarities and differences between factoring and invoice discounting.

What is Factoring?

Factoring is a type of invoice finance in which receivables and unpaid invoices are recovered through the involvement of a third party. In Factoring definition it says that factoring is a financial transaction in which companies sell their receivables and unpaid invoices to third parties such as banks and financial institutions known as factors at a discounted rate. Factoring invoices allows businesses quickly and efficiently to recover their accounts receivable as they do not need to wait on their clients for payment on goods and services offered. When factoring receivables, the third party, typically a bank or financial institution, takes control of the company’s debt collection by maintaining the sales ledger and contacting the customers directly to make their due payments. In factoring invoices, the business’s clients are aware that debt collection has been handed over to a third party as the client directly make invoice payments to the factor. Debt factoring is a type of factoring in which the factor offers the firm a loan against the receivables and unpaid invoices handed over to the factor.

What is Invoice Discounting?

Invoice discounting in another type of invoice finance. Invoice discounting is a form of short-term financing in which a company can obtain loans on its unpaid invoices and receivables. The financial institution or third party offering invoice discounting charges a fee for the service, and loans are made on an agreed percentage of the total invoice value. When customers pay their dues, the amounts go directly to the third party financial institution. The company itself maintains its sales ledger and is responsible for debt collection. Therefore, the company’s clients are not aware of a third party involvement in debt collection. This allows for confidential invoice discounting and helps the supplier maintain healthy customer relationships. Invoice discounting is also a form of asset based lending in which the financial institution offers business loans that are secured by unpaid invoices and accounts receivable.

What is the difference between Factoring and Invoice Discounting

Factoring and invoice discounting are both invoice finance mechanisms that offer short term financing. Despite their similarity, there are a number of differences between factoring and invoice discounting. Smaller firms usually use invoice factoring, as opposed to invoice discounting that is usually used by much larger corporations. In invoice factoring the sales ledger, debt collection and credit checks are conducted by the third party financial institution, and customers are aware that the firm is using the services of a third party. As with invoice discounting, this is quite confidential as the sales ledgers are maintained in house and customers are not aware of a third party involvement.

Summary:

Factoring vs Invoice Discounting

• Factoring and invoice discounting are both invoice finance mechanisms that offer short-term financing.

• The factoring definition: a financial transaction in which companies sell its receivables and unpaid invoices to third parties such as banks and financial institutions known as factors at a discounted rate.

• Invoice discounting definition: A form of short-term financing in which a company can obtain loans on its unpaid invoices and receivables.

• Invoice discounting is also a form of asset based lending in which the financial institution offers business loans that are secured by unpaid invoices and accounts receivable.

• In invoice factoring the sales ledger, debt collection and credit checks are conducted by the third party financial institution, and customers are aware that the firm is using the services of a third party.

• As with invoice discounting, this is quite confidential as the sales ledgers are maintained in house and customers are not aware of a third party involvement.

 

Further Reading:

  1. Difference Between Factoring and Accounts Receivable Financing