Factoring vs invoice discounting: what's the difference?

• Both advance a percentage of your invoice value upfront, often somewhere in the region of 80–90%.
• Both release the balance, minus fees, when your customer pays.
• Both are linked to your sales ledger, so available funding can grow with turnover.
• Both can be arranged on a recourse or non-recourse basis.
• Both are available only for business-to-business invoices on credit terms.

With factoring, the provider takes on your sales ledger management. It sends statements, chases overdue invoices and receives payments from your customers. Your invoices typically carry a notice asking customers to pay the provider.

This can save time and cost if you do not have a dedicated credit controller, and some businesses find the provider's collection processes improve payment times. The trade-off is that a third party is dealing with your customers, so choose a provider whose approach you are comfortable with.

With invoice discounting, you continue to manage your own sales ledger and collect payment. Customers usually pay into a trust account in your name that is controlled by the provider. You report sales to the provider regularly, and it advances funds against the ledger.

Because the provider relies on your processes, it will want to see good credit control, clean records and reliable reporting. It will usually carry out periodic audits of your ledger.

• Who collects: factoring, the provider; discounting, you.
• Customer awareness: factoring, disclosed; discounting, usually confidential.
• Admin support: factoring includes credit control; discounting does not.
• Typical user: factoring suits smaller or fast-growing businesses; discounting suits established businesses with in-house credit control.
• Cost: factoring generally costs more because it includes ledger management; discounting is often cheaper but may have higher minimum turnover requirements.
• Entry requirements: discounting providers often set minimum turnover levels and look closely at your systems.

Both products can be offered with or without recourse. On a recourse facility, you bear the loss if a customer fails to pay and must repay the advance or swap in another invoice. On a non-recourse facility, the provider takes on the credit risk of approved customers becoming insolvent, usually in exchange for a higher fee.

Non-recourse cover normally comes with credit limits on each customer, and it rarely protects you against disputes over your goods or services. Factoring is more commonly offered with bad debt protection built in; with discounting, you may arrange credit insurance separately. Check what is covered, the limits on each customer, and what happens to invoices that go beyond the agreed recourse period.

Both usually charge a service fee plus a discount charge on funds drawn. Factoring service fees tend to be higher because of the collection work involved. Look out for set-up fees, audit fees, minimum monthly fees, bad debt protection premiums and exit fees. Compare the total cost based on your realistic turnover, not the best-case figure.

Factoring is often the better fit if you:

• Do not have a dedicated credit-control resource.
• Are a smaller business that does not yet meet discounting criteria.
• Are comfortable with customers knowing you use finance.

Invoice discounting is often the better fit if you:

• Have established credit-control processes and accurate accounting systems.
• Want to keep the arrangement confidential from customers.
• Have larger turnover and want to keep costs down.

Businesses sometimes start on factoring and move to discounting as they grow. Selective invoice finance, which funds individual invoices, is another option if you only need occasional support. Neither is a good fit if most of your sales are to consumers, if invoices are often disputed, or if you only need a one-off sum, where a short-term loan may be simpler and cheaper.

Welcome Finance is a commercial finance broker for limited companies, LLPs and partnerships of four or more partners. We compare factoring and discounting providers and set out the fees, notice periods and guarantee requirements before you commit. Check your eligibility in 60 seconds; it will not affect your credit score.