Since the financial crash of 2008, it has become increasingly difficult for SMEs to obtain traditional finance from banks, whether via overdraft facilities or business loans. During the same period, alternative lenders have grown significantly and invoice factoring and discounting have become the finance method of choice for many SMEs. In fact, the UK invoice finance industry grew from a total turnover of less than £50 billion in 1996 to more than £200 billion in 2008, according to the Asset Based Finance Association.
Invoice financing: the basics
But before we discuss the differences between invoice factoring and invoice discounting: what exactly does invoice financing involve? In simple terms, rather than using a business asset as collateral, it allows you to borrow against the value of your outstanding invoices.
As soon as you issue an invoice, you will be able to borrow between 70% and 85% of its value, which will then be repaid once your client has made payment. The sooner your clients pay, the less interest you will be charged, which is where the full-service option of invoice factoring comes in.
The advantages and disadvantages of invoice factoring
Available only to business-to-business companies, invoice factoring involves handing your debtor ledger to the finance company, who will oversee all aspects of credit control. Your clients will be dealing with highly experienced credit control professionals, who will be tactful but very focused on securing early payment, thus minimising the interest you pay.
The advantages speak for themselves: you no longer need to employ a credit control team and can significantly reduce your interest costs. On the downside, this does mean that your customers will be dealing with a third party on credit control issues and you will of course have to pay a fee to the factoring company in addition to agreed interest.
The pros and cons of invoice discounting
In contrast, with invoice discounting the finance company is solely responsible for lending and you keep control of your debtor ledger and pursue your own debts. On the plus side, this means that your clients will be speaking to your own staff, with whom they already have a relationship, rather than a third party.
The downside is that your credit control people may not be as experienced as the finance company’s team, and may be less focused on securing early repayment. As a result, you may find yourself paying more interest than is necessary.
In general, most businesses tend to prefer invoice discounting, but those experiencing credit control problems will benefit significantly from factoring. A third option is to choose invoice discounting but build a relationship with a debt collection agency that can focus on slow or difficult payers.
Whichever route you opt for, your business will remain responsible for the value of the invoices, so it is important to be sure that you have chosen the right avenue.