Understanding invoice discounting vs factoring

More than 1.5 million businesses are affected by late payments, costing the UK economy nearly £11 billion per year. If late payments are causing your business cash flow problems, invoice finance (including invoice discounting and invoice factoring) could be the solution – letting you access funds from unpaid invoices almost immediately.

But with two main options to choose from, how do you know if invoice discounting vs invoice factoring is more suitable for your business? Both can help cash flow, but they work in different ways and have unique benefits and considerations. The choice depends on your business needs, customer relationships and how much control you want over your invoices.

In this article, we’ll explain how invoice discounting and factoring work, their pros and cons, the costs involved and whether they might be suitable for your business.

What is invoice financing?

Invoice financing is a way to unlock cash from unpaid invoices before your customers pay them. Instead of waiting 30, 60 or 90 days for payment, you could get most of the invoice value upfront – usually within 24 to 48 hours. It’s a flexible way to manage cash flow, especially if your business faces long payment terms or late-paying customers.

There are two main types of invoice financing: invoice factoring and invoice discounting. Both give you quick access to funds, but they differ in how they work and who handles your customer payments.

• Invoice discounting: You stay in control of collecting payments and your customers won’t know you’re using finance

• Invoice factoring: The finance provider takes over collections, which can save you time but means your customers will be aware of the arrangement

Invoice financing is particularly useful for businesses that need steady cash flow to cover expenses like payroll, stock or growth opportunities. It’s not a loan but rather a way to access your profit earlier. And because it’s based on your invoices, it can grow with your sales.

What is invoice factoring?

Invoice factoring is when you assign your unpaid invoices to a finance provider. They give you a large portion of the invoice value upfront (usually around 80% to 90%) and then take responsibility for chasing your customers for payment. Once your customer pays, you’ll receive the remaining balance, minus the provider’s fees.

Factoring is a popular choice for businesses that don’t have the time or resources to chase late payments. It can also be easier to qualify for than other types of finance, since the provider’s more focused on your customers’ ability to pay than your own credit history. But there are also some potential risks to be aware of. Understanding them will help you make the right choice for your business.

Pros of invoice factoring

• Saves time: The provider handles credit control and collections, freeing you up to focus on running your business

• Improves cash flow: You get most of the invoice value upfront, so you’re not left waiting for customers to pay

• Non-recourse options available: Some providers offer ‘non-recourse factoring’, where they take on the risk of unpaid invoices

• Easier to qualify for: Factoring is often available to smaller businesses or those with less established credit histories

Cons of invoice factoring

• Customers will know: Your customers will be aware you’re using finance, which some businesses worry could affect their reputation

• Higher fees: Invoice factoring tends to be more expensive than invoice discounting, with fees typically ranging from 1.8% to 4% of the invoice value

• Less control: The provider handles collections, so you won’t have direct control over customer interactions

• May require whole-ledger factoring: Some providers insist you factor all your invoices, rather than just selecting a few

Invoice factoring could be a good fit if you’re a smaller business or don’t have the resources to chase payments yourself. It’s also useful if you’re in an industry where late payments are common, like recruitment or logistics.

What is invoice discounting?

Invoice discounting lets you borrow against your unpaid invoices while keeping control of collections. You’ll typically receive up to 95% of the invoice value upfront and repay the borrowed amount (plus fees) once your customers pay.

Discounting can be suitable for businesses that want to keep their financing private and maintain control over customer relationships. It’s also usually cheaper than factoring, making it a cost-effective way to improve cash flow. But, again, there are some potential risks to be aware of.

Pros of invoice discounting

• Confidential: Your customers won’t know you’re using finance, so it’s less likely to impact your business relationships

• Lower fees: Discounting is typically cheaper than factoring, with fees around 1% to 3% of the invoice value plus interest

• More control: You stay in charge of collecting payments, so you maintain direct contact with your customers

• Flexible funding: You can choose which invoices to discount, giving you more control over your cash flow

Cons of invoice discounting

• You handle collections: If you regularly struggle with late-paying customers, discounting might not be the best option

• Higher turnover needed: You’ll usually need a turnover of £250,000 or more to qualify

• Recourse arrangements: If a customer doesn’t pay, you’ll still need to repay the borrowed amount unless you’ve agreed to a non-recourse arrangement

• Not ideal for start ups: Discounting is generally aimed at more established businesses with strong credit control

Invoice discounting could be suitable if you’re an established business with good customer relationships and want to keep your financing private.

The key differences of invoice factoring vs invoice discounting

When comparing invoice discounting vs factoring, the biggest difference between the two is who handles your customer payments.

But there are other important differences to consider, like cost, confidentiality and flexibility.

Costs, fees and the invoice finance application process

The cost of invoice finance depends on whether you choose invoice factoring or invoice discounting, as well as factors like your business size, industry and the creditworthiness of your customers.

With invoice discounting, you’ll typically pay a service fee of around 0.15% to 0.9% on turnover, plus interest on the borrowed amount. Factoring fees are higher (usually 0.4% to 2% on turnover) because the provider takes on more work, including credit control and collections. You will also need to pay interest on the amount borrowed.

You’ll need to watch out for additional costs, like setup fees, minimum volume requirements, early termination penalties, and contract lengths. So check the small print and ask for a clear breakdown of fees before committing.

Applying for invoice finance is usually straightforward. You’ll need to provide details about your business, your customers and your unpaid invoices. The provider will then assess your eligibility based on factors like your turnover, trading history and the creditworthiness of your customers. Once approved, you can typically access funds within 24 to 48 hours.

Invoice discounting vs factoring: Which is right for your business?

Choosing between invoice discounting and factoring depends on your business needs, customer relationships and how much control you want over your invoices.

Invoice factoring might be right for you if:

• You don’t have the time or resources to chase payments

• You’re a smaller business or start up with limited credit control

• You’re comfortable with your customers knowing you’re using finance

Invoice discounting might be right for you if:

• You have strong customer relationships and in-house credit control

• You’re an established business with a higher turnover

• You want to keep your financing confidential

If you’re still unsure, some providers offer ‘selective invoice finance’, which lets you choose which invoices to fund. This can be a good way to test the waters before committing to a full ledger arrangement.

Common myths about invoice financing

There are a few misconceptions about invoice financing that might be holding you back. So let’s clear them up.

Myth 1: Invoice finance means my business is struggling

Reality: Many successful businesses use invoice finance to manage cash flow and fund growth. Consider it a helpful tool rather than a last resort.

Myth 2: It’s only for big businesses

Reality: While discounting often requires a higher turnover, factoring is available to smaller businesses with turnovers as low as £50,000.

Myth 3: Customers will pay late if they know I’m using finance

Reality: Professional providers handle collections discreetly and there’s no evidence to suggest that customers pay late just because you’re using invoice finance.

Wrapping up

Invoice discounting and factoring are both effective ways to unlock cash tied up in unpaid invoices. The right choice depends on your business needs, customer relationships and how much control you want over your invoices.

• Invoice discounting could be a good choice if you want to keep your financing confidential and have the resources to manage collections

• Invoice factoring could be a good choice if you’d rather outsource credit control and don’t mind your customers knowing you’re using finance

Whichever option you choose, invoice finance can help you maintain steady cash flow, reduce the stress of late payments and free up time to focus on growing your business.

Businesses that apply for invoice finance with Tide can receive up to 95% of the invoice value, sometimes in as little as 24 hours.

FAQs

Can I use invoice finance if I’ve been trading less than a year?

Some factoring providers accept businesses with at least six months of trading history, while discounting typically requires over 12 months. If your business is very new, you might need to explore alternatives like invoice finance or revenue-based financing.

Will invoice finance affect my credit score?

Responsible use of invoice finance can actually improve your creditworthiness by demonstrating reliable cash flow management. You’ll receive a soft credit check upon applying for invoice finance and there are no visible footprints left to affect your business credit score.

How quickly can I access funds?

Most providers release funds within 24 to 48 hours of approval, making it one of the fastest ways to access business finance.

What happens if a customer doesn’t pay?

Any unpaid invoices can be covered by additional insurance, which is often offered by invoice finance providers.

Can I switch between factoring and discounting?

Many providers offer both options, so you may be able to switch as your business needs change. But bear in mind that eligibility or approval for switching may depend on your trading history, financial strength and internal credit control processes.

Is invoice finance expensive?

Costs vary, but factoring typically ranges from 1.8% to 4% of the invoice value, while discounting is usually cheaper at 1% to 3% plus interest. It’s a good idea to compare providers to get the most suitable deal for you.

Do I need to finance all my invoices?

Not necessarily. Some providers offer selective invoice finance, letting you choose which invoices to fund. This can be a good way to test the waters before committing to a full ledger arrangement.

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