Factoring vs Invoice Discounting – which works for your small business?

Invoice finance is a powerful means by which small and growing businesses can take control of the value locked up in unpaid invoices. This set of techniques can be split into two: factoring, and invoice discounting. But how do they differ, and how can they help your business?

What is invoice finance?

Invoice finance refers to a set of techniques that allow you to borrow against the value of your unpaid invoices. In an invoice finance arrangement you raise an invoice as normal, and then you pass it on to a third party invoice finance company such as Aldermore. That company then pays you a proportion of the face value of the invoice. When the invoice gets paid, the invoice finance company gets paid too.

What’s the difference between factoring and invoice discounting?

Invoice finance can be split into two categories: factoring and invoice discounting. Each of these two techniques will suit businesses in different circumstances and, perhaps, at different stages in their development.

In a factoring arrangement, you pass responsibility for collecting the debt from your client onto the third party company, which in this case may be referred to as a factor. There are several potential advantages to this arrangement. Perhaps most important of these is that you will no longer have to assume the resource burden of chasing invoices. This can be a time consuming process, and freeing yourself from it can enable you to concentrate instead on running your business.

In an invoice discounting arrangement, meanwhile, you retain control of this process. Clearly, you do not enjoy the potential time benefits associated with factoring – but, crucially, in an invoice discounting arrangement, your clients need never know that you are using invoice finance. They will settle their invoices in the normal way, and they will never have to deal with a factor. This level of discretion can be a major benefit for many businesses.

Do I have to make a long-term commitment?

Traditionally, some small and growing businesses have been put off factoring and invoice discounting because the invoice discounting company has required that they put all or a large proportion of their invoices through the system. Indeed, this is still true in many cases, and while this suits some businesses, it is impractical or unnecessary for others. In these situations, you might wish to consider spot factoring. In these arrangements you can put just one or a small ‘bundle’ of invoices through the finance process, giving you the flexibility you need.

What are the alternatives?

Invoice finance can be a highly effective means by which you can sustain and grow your business, as we explored last week in this article on invoice finance and cashflow. However, it is important to understand that it’s not the only means by which you might choose to finance your business. For more options, read our finance guide for small business.