Many businesses have heard of invoice finance and some of the terms that go along with it – factoring, discounting, spot factoring, CHOCC and more… it can be a difficult area to understand sometimes. However, in principle, it’s really quite simple.
Both invoice factoring and invoice discounting are services where a funder will provide you with an up-front payment against your invoices to your business customers. For example, if you are invoicing a blue-chip firm for the equipment you have sold them, the chances are your customer will take at least 30 days to pay. With an invoice finance service in place, the funder might advance you 80-90% of the invoice total straight away, with the remainder (fewer fees) coming when the invoice is finally settled.
The essential differences between invoice factoring and invoice discounting lie in who takes control of the sales ledger and responsibility for collecting payment, and the level of confidentiality.
With invoice factoring, the funder takes the role of managing the sales ledger, credit control and chasing customers for settlement of their invoices. The customer settles their invoice directly with the factoring company, so your customers are likely to be aware of the fact that you are factoring.
In invoice discounting, your business retains control of its sales ledger and chases payment in the usual way. Your customers pay their invoice amount into an account that is managed by the funding company but is in your name, so confidentiality remains intact without customers knowing a third party is involved.
The Benefits of Invoice Factoring and Invoice Discounting
The benefits of both types of finance are broadly very similar. With either you can:
• Release 80-90% of the value of your outstanding invoices straight away – most invoice finance funders will pay within 24 hours of you sending them your invoice (once an agreement is in place, of course)
• Secure funding without requiring other assets such as property or vehicles – many businesses don’t have physical or tangible assets to use as collateral
• Release cash to overcome cash flow problems or grow the business – particularly helpful if your clients take a long time to pay invoices
• Pay supplier invoices promptly and increase your power to negotiate discounts
• Increase the level of funding available with your turnover
What Types of Businesses Use Factoring and Discounting?
Both invoice discounting and invoice finance is particularly suited to businesses in areas such as:
• Recruitment – particularly recruitment agencies who deal with contracted or temporary employees
• Construction – many construction firms are working as sub-contractors to the larger building companies who are often very late payers
• Printing and publishing
• Courier and logistics
But in almost any business that provides services or goods to other businesses and gives customers credit terms of 30-120 days (after the job has been completed), factoring or discounting can solve the problems associated with slow payment.
Which Is Right for You?
Choosing between invoice factoring or discounting facility will largely depend on the size of your business and your sales ledger management resources.
If your business is relatively small and your human resources limited, the credit-control and collection service that comes with invoice factoring is likely to suit you better.
If your business is larger, and you have the human and information resources to efficiently manage your own sales ledger and debt collection — or if you feel strongly that you want your own company to deal with debt collection — invoice discounting is likely to be your preferred option.
Other Financial Services to Consider
Sometimes, invoice finance (factoring or discounting) isn’t appropriate. For example, if your business doesn’t issue invoices at all. It can also be difficult if you are invoicing customers for ‘incomplete’ services such as on-going consultancy.
Other products are available which can help with working capital and cash-flow, including revolving credit facilities (which operate in a similar way to overdrafts, but without the bank) or standard business loans. Business loans can be secured or unsecured. Secured loans require you to have assets (such as property, vehicles or machinery) to secure against the loan. Unsecured business loans don’t require the physical assets but may require you to issue a Personal Guarantee and often require you to have a higher turnover relative to the loan amount required.