Invoice Discounting VS Factoring (Advantages & Disadvantages)
The simple definition for both invoice discounting or invoice factoring is a financial transaction and a type of debtor finance in which a business sells it's accounts receivable like invoices or bills to a third party (called the factor) at a discount. A business will sometimes factor its receivable assets to meet its present and immediate cash flow needs. Invoice finance means you get cash upfront against your unpaid sales invoices.
What is the difference between Invoice Discounting and Invoice Factoring?
Invoice Discounting (Self-managed Invoices)
Invoice discounting is a process or way to raise cash flow for your company. To do this your company will receive a payment as an advance from the financing company or lender and you retain control of the invoices itself (Self Managed).
When payments are received from your customers, the cash goes directly into a bank account that is managed by the lending company. With this type of arrangement, the lender sometimes provides you with bad debt insurance. By using an insurance backup scheme,
your company will not be responsible for paying for the debt if your customers default and not pay their invoices in furture.
Invoice Factoring (Invoices Managed By Factoring Company)
Invoice Factoring also gets you advanced cash on the value of the invoices, but the process works a little bit differently. With invoice factoring, you get the cash advance based on the value of the invoices and the factoring company takes possession of the invoices or manages your accounts receivables. The factoring company takes over the management of approving customers for factoring as well as collecting payments. Your customers will start receiving statements from the factoring company and if they did not pay their invoices, they'll receive phone calls and other debt collection actions from the factoring company. This means that all the responsibility is transferred from your company over to the financing company.
With Invoice factoring, there are actually two different types of factoring arrangements that you company could enter into. Your company could opt for recourse or non-recourse invoice factoring. With a recourse invoice factoring arrangement, your company is still responsible for the advance you receive if your customers default on the balance in the future. Your company will be responsible to pay back none-paid invoices. With non-recourse invoice factoring, your company can get access to the advanced cash, but does not have to pay it back if the customer does not repay what they owe. This puts the financing company at risk and no risk to your company.
*Note, we provide invoice discounting or factoring facility to all other industries as well. Fill-out the form on the left hand side of this page to get started.
Advantages of Invoice Discounting and Factoring
Quick Cash Flow Normally in 24 hours. Invoice discounting/factoring is comparatively quicker and faster way to raise cash than applying for a Cash Credit in which lending institutions or banks take quite a lot of time in credit approval of the borrower.
Unlock Cash Invoice factoring/discounting releases cash that has been locked in customer invoices for a long period of time. Invoice discounting/factoring converts the company's account receivable (debtors) into pure cash. This may even be useful in cases or emergencies.
Cash can be obtained without using any assets as collateral. Only surety such as invoices to which customers are yet to pay are to be submitted for the transaction.
Expansion and Growth Invoice factoring/discounting allows companies to expand and grow when cash is needed to take the business forward. It can provide cash flow for business expenses.
Confidentiality In the matter of invoice discounting, confidentiality can be achieved by self-managed invoice accounts. The customers or suppliers need not know about the borrowings of the company against sales invoices.
Disadvantages of Invoice Discounting and Factoring
People's Perception & Reliance Some people perceive invoice discounting or factoring as a stigma over the company, hence, excessive reliance on invoice factoring or discounting may not be taken very positively by all stakeholders.
Excessive Use Excessive usage of invoice discounting/factoring facilities may cause management to be non-focussed on strengthening their own cash flow cycle. The company should ideally be focussing on shorter invoice periods and not invoice factoring/discounting as a mechanism to improve cash flow cycles.
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