Once you have established that you need help in managing your cash flow, the good news is invoice financing gives you a choice between two services: invoice factoring and invoice discounting.
Both offer invaluable support to companies struggling with cash flow as a result of the late, or non-payment of invoices by customers, but each is quite different in the extent of support they offer.
First, let’s consider what these two options for financing your receivables offer your business. By signing up for invoice factoring, you are tasking the finance company with taking over full responsibility for financing, managing and collecting your outstanding invoices. Whereas if you opt for invoice discounting, the finance company merely finances your invoices at a discount upfront and you remain in control of the management and collection process.
Let’s consider what the key differences are and then how these might suit different companies depending on their circumstances.
Invoice factoring hands full control of your debtor book to the financing company, which means that the invoice financing company will contact your customers and chase them up for payment. The invoice finance companies have an in-depth insight into your account receivables and will be far more involved in assisting you in managing this efficiently and effectively.
Invoice discounting offers you a way to finance your invoices on a discounted basis. You decide which invoices you would like to fund through the financing company. The funder, after assessing the payment history of the customer, then hands over a percentage of the invoice, usually between 60% to 95% of the funds. ( On collection of the invoiced amount, the provider then forwards the remaining amount, less the fee for their services.
Given that an invoice factoring agreement offers significantly more extensive, ongoing services, the finance company will charge more. But you need to balance this with the cost of setting up these human and hardware resources within your own business.
Invoice discounting merely charges you a percentage of the invoiced amount and is thus is often more cost-effective than an invoice factoring funding and business invoice management service.
Invoice discounting provides you with more flexibility and greater control of the debtor financing process. You will know what is going on every step of the way and can opt to finance specific invoices and not others depending on your immediate cash flow needs or your history with different payers, where you know some are less likely to pay on time than others.
Meanwhile, invoice factoring may be a less flexible finance offering but does give you an established, ongoing financing service, with the associated ease of access, certainty and security in managing your cash flows during seasonal and possibly unpredictable periods in the business and broader macroeconomic environment.
Why set up an invoice factoring arrangement with a finance company?
If you are a small business that needs to focus on the day-to-day of growing your revenue, outsourcing your invoice management may be a good solution.
Also, you may not have the requisite finance skills and know-how to manage your accounts receivables, whereas the invoice financing company would offer their many years of experience and professional skills in managing account receivables.
But this also means you outsource the invoice management, payment and collection process. You will then be leaving it in the hands of the provider as to how the deal with your customers.
In addition, these contracts usually come with very high fees and can be very difficult to break if you change your mind. At Apricity, we often meet with businesses struggling to get out of such contracts.
Why would you choose to contract on an invoice discounting basis, instead of invoice factoring?
If you have close relationships with your clients and would prefer to remain the first point of contact for them, invoice discounting would be preferable for you.
Your customers may also prefer to deal with you rather than an unknown, faceless third-party company – especially if they are small companies too and don’t have large finance departments that process invoices in a more structured and impersonal way.
In contrast, there are circumstances where it may be beneficial for customers to be aware that you have contracted a third-party to manage your account receivables, particularly those who have a history of non-payment. An arm’s length, matter-of-fact collection process would shift the payment process into a more formal, impersonal basis.