When it comes to managing cash flow, businesses have several options to convert their outstanding invoices into immediate working capital. Two of these methods, the most frequently employed are invoice discounting and invoice factoring. They both can offer a major improvement in the liquidity yet function differently and represent the demand for various businessmen. In this detailed article, we will learn the nuances of these methods of financing, including the trends into business decision-making.
Invoice Discounting: An Overview
Invoice discounting is a method through which organizations are able to secure a payment from a third party on the basis of money received from clients. Contrary to conventional forms of financing mortgage, for example, invoice discounting offers cash on the basis of your current accounts receivable. This method is quite widely used by various businesses that cannot wait to start receiving cash flow and have to make their purchases right away.
How Invoice Discounting Works
Invoice discounting works as follows:
- Invoice Issuance: In the current system, upon delivering the products or rendering the services, the business firm prepares and sends invoices to the customers.
- Submission to Lender: The business then sends these invoices to an invoice discounting provider.
- Advance Payment: Provider pays a portion of the invoice value in the form of progression, which ranges between 80 and 90%.
- Customer Payment: On the due date the customer makes the payment through the invoice, and this amount is directly transferred to an account that is controlled by the lender.
- Balance Payment: The remaining amount of money that is passed back to the business is arrived at by the lender and their fees and interest charged.
Benefits of Invoice Discounting
Are you wondering if invoice discounting is a good idea? Invoice discounting has multiple advantages provided by even the most prominent financial institutions like banks and NBFCs. Have a look at them one by one:
- Confidentiality: This means that the customer has no information that she or he is being billed at the said lower rate.
- Retained Control: The business still controls its sales account and management of customer accounts.
- Quick Access to Funds: Tends to provide the ability to obtain cash in working capital quickly.
Invoice Factoring: An Overview
Invoice factoring can be described as a process of selling other unpaid invoices to a factoring company in exchange for a lower price. The factoring company then assumes the role of collection from your customers or clients as your documents pass through the factoring company’s hands. This method is particularly appropriate for corporations that would prefer to contract out their credit control and collections.
How Invoice Factoring Works?
Invoice factoring works as follows:
- Invoice Issuance: The nature of business is that it provides products or services to its customers and sends bills to its clients.
- Sale of Invoices: These invoices are sold to a factoring company, that is if it is a good person to do business with.
- Advance Payment: The factoring company provides the business an upfront cash sum which is a small percentage of the total invoice amount, ranging from 70% to 85%.
- Collection Process: Customers pay the factoring company directly This payment collection process is a necessity among UK suppliers.
- Balance Payment: Thus, factoring few of their charges, and the factoring company makes the remaining balance to the business.
Benefits of Invoice Factoring
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- With how Invoice factoring works, it’s equally important to understand the possible pros in order to make a more informed decision.
- Outsourced Collections: One of the functions that are outsourced within the factoring company is the credit control and collections process.
- Reduced Administrative Burden: Cost effective because the billing is done by the software, freeing up time and staff.
Improved Cash Flow: Offer unpredictable working capital which is available for use the moment it is sold.
Choosing the Right Solution for Your Business
The decision concerning the option that will be made between invoice discounting and invoice factoring is an important decision that any business enterprise will have to make when it tries to improve its cash flow. It is important to note that each solution entails its own advantages and disadvantages based on the requirements and environment of your enterprise. Here’s a detailed exploration of how to choose the right solution for your business:
Invoice Discounting
This is the subtle approach to financing where very little overt action is taken by the financing parties and their involvement is just as discreet as is the infusion of capital.
Ideal for Businesses That:
1. Want to Maintain Control Over Customer Relationships:
- Customer Confidentiality: Invoice discounting does not disclose customers. Here, your customers are oblivious of the fact that their invoices have been utilized as collateral to access cash. This can be of particular value if you work in a formal setting and wish to share information while keeping up the appearance of effectively managing customer interactions.
- Autonomy in Customer Interactions: Since the business has some form of control over who handles its sales ledger it will be in a position to manage its customer relations or dealings without any outside influence from third parties.
2. Have Strong Internal Credit Control Systems:
- Self-Managed Collections: As for the invoice discounting the recovery period burden stays in the business to recover the cash from clients. This implies that only businesses that have strict credit control policy and are able to efficiently manage collection of credits will benefit from this kind of financing.
- Risk Management: For those companies which can accurately evaluate the risk of consumer default and have the capability to bear it, then they would also benefit a lot from the structure of independent invoice discounting.
3. Prefer Confidentiality Regarding Their Financing Arrangements:
- No Disclosure to Customers: In fact, invoice discounting involves the involvement of third parties but customers are rarely informed of the financing arrangement. This can be useful in ensuring that business does not suffer from fluctuations in its image and that customers do not develop worries and doubts about the financial situation of the business.
- Professional Image: There may be some advantages in the fact that companies do not disclose information regarding financing arrangements, especially if they would like to avoid certain expectations or associations in the market.
Additional Considerations for Invoice Discounting
- Cost: Typically, invoice discounting is cheaper compared to factoring due to the fact that the business retains control of credit control and recovery. Charges that may be levied may be interest on the amounts provided and a service charge may also be expected.
- Speed: Funds are easily obtained and thus the payments can reflect on the invoices in as little as 24 to 48 hours.
- Flexibility: Some advantages owe to the fact that it is business’s discretion on which invoices to factor, and as such they have more room in controlling their cash flow.
Invoice Factoring
This system refers to the practice of managing all aspects of an organization’s finances.
Ideal for Businesses That:
1. Prefer to Outsource Their Credit Control and Collections:
- Outsourced Collections: Invoice factoring involves companies buying invoices from businesses and the companies that buy the invoices are supposed to collect the money from the customers on behalf of the business. It is often a relative strength for companies that do not have internal staffing or relevant skills necessary to manage collections.
- Reduced Administrative Burden: One of the benefits of credit control outsourcing is that organizations are relieved of the burden of collection that takes their attention away from significant organizational enterprises.
2. Need Immediate Working Capital and Are Less Concerned About Customer Awareness:
- Quick Access to Funds: It allows companies to obtain working capital quickly and this may be necessary so much especially to firms facing some cash flow constraints.
- Customer Notification: This method is ideal for business firms that do not mind customers being informed they are dealing with a firm that has been factored since customers are informed and pay via the factoring firm.
3. Have Limited Internal Administrative Resources:
- Support Services: Credit checks, risk assessment and credit insurance services offered by factoring companies can also be valuable to the company that may not afford to hire these services for their limited capacity.
- Credit Protection: There can be credit insurance, which provides protection to the business from the buyer’s non-payment to the seller of the factored accounts receivables.
Additional Considerations for Invoice Factoring:
- Cost: Much higher unit costs are associated with factoring than with discounting because of the complementary services offered. These comprise factoring cost, which is calculated as a percentage of the stream of invoices and interest charged on the amount that has been funded.
- Impact on Customer Relationships: Given the fact that the factoring company deals directly with customers, some aspects related to their relationship must be handled professionally and choosing a satisfying factoring company provides you this chance.
- Risk Mitigation: It is very helpful that factoring companies may also offer credit protection to customers which decreases the probability of customers’ non-payment.
Making the Decision
When deciding between invoice discounting and invoice factoring, consider the following factors to determine which solution best fits your business needs:
Business Size and Structure
- Large Enterprises: Again organizations with large scale credit control team or separate credit control division may find invoice discounting necessary to keep their business discrete.
- SMEs: Due to the efficiency and effectiveness of invoice factoring, some industries or businesses that may benefit significantly include: SMEs, businesses that cannot afford credit control mechanisms.
Nature of Customer Relationships
- Long-Term Relationships: Some organizations such as those with long-standing business relationships with customers may find it preferable to use invoice discounting as it is confidential in comparison to factoring.
- Transactional Relationships: While many may lose customers through invoice factoring, others such as those dealing with transactional client base will likely benefit from the advantages of the tool more than they will suffer from the perceived consequences.
Administrative Capabilities:
- In-House Expertise: Large companies succeeding in particular administrative functions and credit control may find invoice discounting more preferable.
- Limited Resources: Lesser administrative capabilities of businesses may consider invoice factoring more preferable because a company’s credit control function is often underscored within this mechanism.
Cost Considerations:
- Budget Constraints: Perhaps this is the reason why most businesses find Invoice discounting to be cheaper than other discounting options in occasions where their budget is limited.
- Value of Additional Services: However, if the factoring also offers supplementary services like credit protection and collections, the higher cost may be worth it because the factoring company is offering such services.
Need for Confidentiality:
- Maintaining Professional Image: This is because the fact that invoice discounting is not made public can help in upholding the image of the business by ensuring that the clients’ confidence in the business is retained especially when the business is likely to go bankrupt.
- Transparency Acceptance:Many organizations may consider invoice factoring acceptable because it is not as relevant for customers to be aware of the financing arrangements as with other types of factors.
Difference Between Invoice Discounting and Invoice Factoring
To make the concept clear, we have provided you with a table that will help you clearly see the key differences between invoice discounting and invoice factoring. It will make it easier to determine which solution might be best for your business needs.
Conclusion
Invoice discounting and factoring products both provide useful solutions when businesses need to increase cash flow and work on their working capital. It, therefore, becomes important to realize the fundamental differences between these two methods so as to assess which one would be ideal for the needs of the business.
Invoice discounting is a confidential kind of finance that has many strings attached to it and is preferred by many companies as it enables it to maintain full control of customer relationships and credit control. However, invoice factoring entails full credit control and collection and thus is suitable to companies that would want to outsource those responsibilities.
Since there has been an increasing trend of companies seeking invoice financing, more platforms like Credlix are making it easier and more effective. Based on the usage of digital technology, Credlix has enabled working capital financing by providing prompt funds through invoice discounting with reduced paperwork and without asking for any rigid physical guarantee.
If you are an SME that is striving to maintain adequate cash flow within your business, or an exporter that is in need of quick recovery on sales made, then Credlix is for you. Stay informed about the advantages of invoice discounting with Credlix and boost your business to the next level.
Also Read: What’s the Difference Between Invoice Discounting and Invoice Factoring?
