Invoice factoring and invoice discounting: what’s the difference?
As a small or medium enterprise, you may be looking for an alternative source of business finance – a funding mechanism that does not carry the same limitations as a traditional bank loan. You may need faster access to finance than the banks are able to give you; or you may be looking for a working capital solution that grows with your turnover.
Factoring is a financing strategy adopted by businesses around the world to unlock the cash that is tied up in their accounts receivable (i.e. invoices). Instead of waiting months and months for the payments due to you on your credit sales, a factoring company can advance working capital against your outstanding debtor balances.
This is a smart way to stay cash flow positive, so you can continue paying your operational expenses while also funding your business growth plans. The amount of money you receive is based on your invoice amounts and not tied to bricks and mortar value, so you can access an amount that is commensurate with your income.
Invoice factoring or invoice discounting?
Invoice factoring is often confused with – or compared to – invoice discounting. While these two financial services have some similarities, they are not one and the same.
With both invoice factoring and invoice discounting, a third party provides the working capital against the accounts receivable of a business. With factoring (or sometimes referred to as “invoice factoring”), the third party (a factoring company or Factor) buys the credit sale invoices from you. With invoice discounting, the third party generally uses the accounts receivable as collateral for the funding.
There is no loss of equity or control of the business with either option.
Sales ledger management
When you enter into a factoring agreement, the factor acts as your accounts and credit control department, taking over the following functions:
- Opening accounts for new customers;
- Managing credit checks and assessing credit limits;
- Handling collections and payments;
- Sending reminder letters and final demands where necessary;
- Assisting in settling of disputed accounts; etc.
With invoice discounting, on the other hand, all these roles remain your responsibility. You continue to administer your own sales ledger, chase payments and manage credit control processes.
Due to the amount of back office support provided, which frees up time and other resources, factoring will most likely appeal if you do not have the budget, staff, time or patience to manage these functions in-house. Essentially, factoring gives you an expert and highly professional credit control team at your side.
Acknowledging that there’s a third party involved
When you opt for the factoring route, your customers will be made aware that you have handed your debtors’ book over to a factoring company.
With invoice discounting, however, you continue to collect payments from your customers directly, and they are usually unaware that there’s a third party involved.
While confidentiality may be very important to you, it’s essential to note that factoring is a well-established and well-respected financing method worldwide – for many different reasons.
Many companies choose to factor their invoices to ensure that they have enough cash available for growth, whether they’re planning to buy more stock, upgrade equipment, increase their talent pool or expand their footprint. An expert and professional factoring company can explain their involvement to your customers in these terms, dispelling any concerns they may have around dealing with a third party.
Which option is best for your business?
Every company has own unique business goals, financial needs and customer relationships. All these issues will influence the decision between factoring and invoice discounting.
If factoring sounds like the right option for your business, be sure to select a factoring company that has the experience, reputation and independence to provide your business – and your valued customers – with the exceptional level of service deserved.
Why choose Merchant Factors?
Merchant Factors has been providing working capital solutions to SMEs and growing businesses for almost 30 years. The company was founded to offer organizations in South Africa with a sound alternative to traditional bank loans and overdrafts – and today, Merchant Factors is the leading independent factoring specialist.
Bringing a team of expert credit-control professionals with it, Merchant Factors liberates businesses from having to evaluate their customers’ creditworthiness, phone debtors for payments due, send reminders and final demands, or handle receipting and reconciliations. This enables small business owners to focus on business issues instead of wasting hours and hours chasing payments and juggling other sales ledger duties.
Merchant Factors’ independence, experience and flat organisational structure means that, unlike many larger financial services institutions, it can customise its facilities to suit most small and medium size emerging businesses, no matter whether their turnover is R100,000 or R15 million per month.
This independence also enables Merchant Factors to offer the shortest turnaround time in the industry from application to pay-out.
For fast, flexible invoice financing – contact Merchant Factors today.
Finance beyond the Numbers.