Invoice Finance – what’s the difference between Invoice Discounting and Factoring?

In today’s challenging economic market, maintaining a healthy cash flow is essential for growth and for day-to-day operations. For many UK businesses, especially small and medium-sized enterprises (SMEs), unpaid invoices can strain liquidity and hinder progress. Invoice finance is a popular and effective solution, enabling businesses to unlock the value tied up in outstanding invoices. Two of the most common forms of Invoice Finance are Invoice Discounting and Factoring. While both share similarities, significant differences set them apart—differences that can influence a company’s choice depending on its size, structure, and needs. We delve into the distinctions between invoice discounting and factoring, exploring their mechanics, advantages, areas to consider, and suitability.

Understanding Invoice Finance: The basics

Invoice finance is an umbrella term for financial solutions that allow businesses to release funds that are tied up in unpaid invoices, enabling firms to access working capital quickly, rather than waiting for customers to pay on standard credit terms, which might be 30, 60, or even 90 days. The two primary forms—invoice discounting and factoring—achieve this in different ways.

What Is Invoice Discounting?

Invoice discounting is a form of invoice finance where a business can release the cash tied up in the value of outstanding invoices, typically up to 90% of the invoice value. The funder advances funds to the business to draw down at a time of their choosing.  The firm continues to manage its own sales ledger and collects payments from its customers as usual.

The process is straightforward:

• The business delivers goods or services and raises invoices to its customers
• Copies of these invoices are sent to the funder
• The funder advances a percentage (normally between 80-90%) of the invoice value
• When the customer pays the invoice, the funder releases the remaining balance, minus agreed fees
• The business continues to manage its own sales ledger and invoice collection process

Types of Invoice Discounting

There are several variations of invoice discounting, including:

• Disclosed Invoice Discounting: Customers are aware of the funders’ involvement, and they are informed that their payments should be made into a designated bank account, but the business manages their own collections and sales ledger
• Confidential Invoice Discounting: Customers are unaware of the funders’ involvement
• Selective Invoice Discounting: The business chooses specific invoices to finance, rather than the entire sales ledger.

What Is Factoring?

Factoring, sometimes referred to as debt factoring, like invoice discounting, sees the funder releasing typically up to 90% of the funds tied up in unpaid invoices.  The key distinction is that the funder takes over management of the sales ledger and the responsibility for collecting payments from customers. The client’s customers are notified and instructed to pay the factoring company directly.

The typical process involves:

• the business provides goods or services and invoices its customers as normal
• copies of these invoices are sent to the funder
• The funder advances a percentage of the invoice value, usually between 70-90%
• The funder manages the businesses credit control process and collects payment from the customer
• When the customer pays the invoice, the funder releases the remaining balance, minus agreed fees

Types of Factoring

There are several types of factoring solutions:

• Full-Service Factoring: The funder provides finance and takes over credit control and collections
• Recourse Factoring: As per Full-Service Factoring but the business is liable if the customer defaults on payment
• Non-Recourse Factoring: As per Full-Service Factoring, the funder takes on the risk of bad debt should the customer default
• Selective Factoring: Like selective invoice discounting, the business can choose certain invoices to finance rather than the full sales ledger

What are the key differences between Invoice Discounting and Factoring

While invoice discounting and factoring both improve cash flow by releasing funds from unpaid invoices, several differences distinguish them:

1. Confidentiality and Customer Relationship

• Invoice Discounting: This solution can be confidential; the end customers are not aware of the arrangement as the business maintains its relationship with customers and manages sales ledger and collections internally
• Factoring: Customers are notified, and the funder collects payments directly from customers. With this solution, the funder has a direct involvement in the customer relationship, as clients interact with the funder instead of the business

2. Credit Control and Administration

• Invoice Discounting: The business is responsible for their own credit control, chasing invoice payments, and managing their sales ledger. This requires internal resources and strong financial processes
• Factoring: The funder handles all credit control and collections, freeing the business from this administrative burden. This is especially beneficial for smaller businesses lacking dedicated credit control staff

3. Suitability and Eligibility

• Invoice Discounting: This product is suitable for established businesses with robust internal credit control resources and a track record of reliable collections. Funders may require minimum turnover thresholds or audited accounts.
• Factoring: This solution is accessible to businesses of various sizes, including start-ups and those with less experience and resources in credit management.

4. Costs

• Both products typically involve two fees.  Firstly, a cost of finance which is based on the amount of funding you use.  The second being a service fee.  Factoring can be more expensive because the service fee is higher as you are taking advantage of outsourcing your sales ledger management and credit control processes.

5. Impact on Balance Sheet

• Both forms of finance are typically off-balance sheet, improving liquidity ratios. However, in some cases, factoring (especially with recourse) may be treated differently in accounting terms.

6. Risk Management

• Non-recourse factoring provides protection against bad debt, transferring the risk to the funder. Invoice discounting does not; the business remains responsible for any defaults.

Advantages and things to consider

Invoice Discounting

Advantages:

• Confidentiality: Your customers are generally unaware that you’re using invoice finance, preserving your existing customer relationships.
• Maintained Customer Relationships: You maintain direct control over your sales ledger and continue to manage your customer relationships and collections in-house.
• Lower Fees (Potentially): Since you handle collections, the fees for invoice discounting can sometimes be lower than factoring, especially for established businesses with strong credit control processes.
• Improved Cash Flow: Similar to factoring, it provides quick access to funds tied up in unpaid invoices, helping manage cash flow.
• Flexibility: You can access funds as needed, based on the value of your invoices

Things to be aware of:

• Requires robust credit control and internal reporting systems to be suitable
• May not be accessible for new or small companies
• Does not protect against customer non-payment (although Bad Debt Protection can be available)

Factoring

Advantages:

• Outsourced Credit Control: The factor handles chasing payments, freeing up your time and resources to focus on core business activities. This can be particularly beneficial for smaller businesses or those without dedicated credit control teams.
• Reduced Risk: In some cases (non-recourse factoring), the factoring company may bear the risk if your customer doesn’t pay. However, recourse factoring, where you remain liable, is more common.
• Improved Cash Flow: You get immediate access to cash that would otherwise be tied up for weeks or months, helping you manage payroll, supplier costs, or support to seize new opportunities.
• No impact to your balance sheet; Factoring is a sale of assets (your invoices), not a loan, so it doesn’t add debt to your balance sheet.
• Growth Support: Access to consistent cash flow can support business growth and expansion.

Things to be aware of:

• Customers are aware of funders involvement
• Higher service fees due to credit management services

Which Solution Is Right for Your Business?

Choosing between invoice discounting and factoring depends on a variety of factors:

• Size and maturity of the business: Established companies with strong financial processes may be more suited to invoice discounting. Smaller businesses or start-ups may benefit more from factoring
• Internal resources: You should consider whether the business has the staff and systems to manage credit control and internal reporting effectively
• Desire for confidentiality: If maintaining direct customer relationships is critical, invoice discounting is usually preferable.
• Risk appetite: If concern about bad debts is high, non-recourse factoring offers added security.

Legal and regulatory considerations

Both products are widely used in the UK and are self-regulated by UK Finance.   Contracts should be carefully reviewed to understand all terms, conditions, fees, and recourse arrangements.

Conclusion

Invoice discounting and factoring are both effective funding solutions for business, each with unique features, benefits, and things to be aware of. Invoice discounting offers privacy and control but demands robust credit management and reporting systems, making it more suited for established firms. Factoring provides valuable support for growing businesses or those lacking in-house infrastructure, at the cost of some confidentiality and higher fees.

Ultimately, understanding these differences is essential for choosing the right solution—one that aligns with your company’s operational realities, growth ambitions, and customer relationships.

Link to further reading

Why UK businesses should choose Invoice Finance.