When a business faces financial crisis and with the growing demand for working capital in the market, securing finance to meet your daily business needs has become an item of luxury. The banks are growing to be even less credit-friendly as they were and obtaining working capital is becoming more and more difficult for both small and large scale companies. In this post we look at invoice discounting vs factoring and how it can impact on your small business.
For those not familiar with Invoice Discounting, it is simply a short term loan provided by financial agencies to the business owners, utilizing the unpaid sales invoices as collateral. Factoring on the other hand is the selling of the invoices to a third party at a discount. While both the terms may sound the same to many, there are often noticeable differences between the two.
Invoice Discounting Vs Factoring
- Factoring arrangements are a complete sale of ownership of the debt owed to your company to a 3rd The invoices are sold at a discount with an agreement that the payment for the invoices will directly be collected by the 3rd party which is also known as the ‘Factor’. This not only provides immediate cash flow into your business but also relieves you of the burden of collecting debts for the unpaid invoices. Chasing unpaid invoices is often a time consuming process which can affect your business further. Factoring thus takes care of your short term finance requirements and your debt collections.
- Invoice Discounting on the other hand, is a loan borrowed against the invoices which are held with the financing organization. As compared to Factoring, the business owners retain the right to collect the payment for the pending invoice. The finance company also charges a monthly fee and interest on the loan. While this doesn’t provide the same benefits as Factoring, it is more helpful in maintaining client relations. The Invoice Discounting is often done on a confidential level between the business and the financing company and the client will never get to know about the funding.
What Should You Consider For Your Business?
If you own a small business it is often confusing to choose between Invoice Discounting and Factoring as both of them have a fair share of pros and cons. Although, both are being put off by several businesses due to the financing organization’s high demands from the applicants and only suits a handful of businesses. Factoring indeed seems to be a better choice for small businesses as you have a flexibility of putting only a portion of your total invoices for sale while still maintaining your valuable and more trusted clients.
One must remember that most small businesses thrive on the healthy client relationships and selling up the more profitable clients can stain your business’ reputation in the long run.
Despite of Invoice Discounting and Factoring being popular the popular means to raise short-term finance can provide several disadvantages to small businesses. One can also opt for the several other means for finance, available for small businesses. Short-term bank loans, invoice financing, equity financing, peer-to-peer lending, government loans and grants etc. are the various other methods through which working capital can be raised for your business.