The difference between Invoice Financing, Invoice Factoring and Invoice Discounting
There are key differences even though the three terminologies sound similar
Besides sharing the same first name and similar use case, that’s where their similarities end. Here is their biggest difference – Invoice financing allows you to use your invoices as financial proof that you can pay the lender back on an advance. Invoice factoring involves selling your invoices to a third party whereas with invoice discounting, your business maintains its responsibility for its own credit control processes ( such as sales ledger, payment chasing and invoice processing) and your customer would not need to know of any 3rd party involvement.
Here is a quick lowdown:
- Invoice Financing “businesses who choose to borrow money against the amounts due from their customers.”
As opposed to taking up a business loan, invoice financing allows businesses to strengthen their cash flow by borrowing money based on amounts due from their customers.
You can monetise your account receivables / unpaid invoices. Instead of waiting up to 150 days’ for payment, your business can obtain working capital from Day 1 of issuing the invoice, often within 48 hours of sending the verified invoice. When the invoice is due, your buyer makes payment, and your business will receive the balance (minus interest and fees).
- Invoice Factoring “businesses who fund their cash flow by selling their invoices to a factoring company at a discount.”
The differentiating factor which sets invoice factoring apart is the essential qualifying requirement – having outstanding invoices from approved and credit worthy clients and who handles customer payments.
- Invoice Discounting “businesses who choose to maintain control over the collection of payments and their customers need not know about any 3rd party involvement”
A business owner would send an account receivable report to the finance company (at least once a month), aggregating receivables into the categories required by the lender. Then the lender uses this information to adjust the amount of debt that it is willing to loan the borrower.
Validus Invoice Financing vs Invoice Factoring vs Invoice Discounting
|Validus Invoice Financing||Invoice Factoring||Invoice Discounting|
|1.Flexibility||More flexibility to choose which invoice to finance and when||Less flexibility as you can only finance specific invoices||More flexibility but most of the time would require to finance your entire invoices|
|2.Price Point||Starting from 1% per month (depending on the invoice amount)||Varies from each lender|
While lenders often quote favourable rates at the outset, consider the additional extra fees they could add every month which makes it a more expensive choice
|Varies from each lender|
Typically charges for a combination of the management fee, establishment fee and the interest charges in order to determine the full cost of financing
|3.Payment Collection Process||Business deals directly with the customer for repayments||Factoring company will retrieve payments on your behalf||Allows business to deal directly with customer for repayments|
|4.Confidentiality||Options available depending on whether you choose to disclose to the customer.||Customers will be contacted directly by the factoring company for payment arrangements||Customers would not need to know that you’re using a finance facility|
Here are four factors to consider when deciding whether which one will work best for your business:
#1 – Flexibility
Invoice Financing – You get to pick and choose which invoices to finance, as and when needed.
Invoice Factoring – Expect less flexibility as the invoice amounts are typically advanced in the order received.
Invoice Discounting – The lender will usually require you to finance your entire debtor book. (i.e. all of your current outstanding invoices)
#2 – Price Point
Invoice Financing – Typical monthly rate will start from 1% and it would depend on the amount of your invoices.
Invoice Factoring – Definitely a more expensive type of business financing and therefore not recommended as an ideal solution in the long term.
Invoice Discounting – Generally charges for a combination of the management fee, establishment fee and the interest charges in order to determine the full cost of financing and it is usually very expensive.
#3 – Payment Collection Process
Invoice Financing – You will continue to deal directly with your customer for repayments, allowing you a slight advantage in terms of negotiating payment terms and even throw in a goodwill gesture to build better relationships with your customer. A happy customer is the best review, and who better to hear it from than the horse’s mouth?
Invoice Factoring – You would not need to handle collection of payment as it will be handed over the factoring company who will usually have their own in-house debt collection to retrieve payments on your behalf. It is also important to note that the cost is determined by your customer’s bad credit. Most factoring companies look at your clients’ credit scores to determine your fees and not yours.
Invoice Discounting – You will continue to deal directly with your customers for payments.
#4 – Confidentiality
Invoice Financing – Unless you have chosen to disclose, your customer will never need to know that you are using a financing company. Platforms like Validus offers both disclosed and non-disclosed payment whereby a ‘Notice to Redirect Payment’ will be sent to the end-buyer so that payment is made directly to Validus (held in an escrow account) for the former and the SME borrower will be assigned a sweeping account in their name but managed by Validus (an escrow account) and informs the end-buyer to make payment to this account for the latter.
Invoice Factoring – Since payment is handled by the factoring company, customers will be aware upon receiving contact from the third party. Note, some of them might not be comfortable and we recommend checking in with your customer.
Invoice Discounting – As you continue to deal directly with your customers for payments, you can maintain confidentiality at the same time because they would not need to know any 3rd party involvement.
When making your final decision, here are some important takeaways for your consideration:
- Invoice factoring takes in the whole outstanding sum whereas invoice financing only takes in invoices that you want to sell. This means you will continue to remain in charge of your accounts and your business.
- Companies with relatively high profit margins will find invoice discounting a good fit as they are in a position to be able to readily absorb the higher interest charges associated with this particular form of financing. In general, invoice discounting is seen as ‘the last resort’ due to the substantial fees associated with it. Business owners would take it on only after being rejected for most other forms of financing.
As a business owner, you need to understand all of the fees and how you are being charged then calculate the true cost of financing. This will help you decide on the best pragmatic and cost efficient approach to help you get paid for your invoices now.
Your business must be registered on ACRA, with an operating history of at least 2 years, and a minimum annual revenue of at least SGD 500k.
Here’s what you need to send in*
- Bank Statements (past 6 months)
- Financial Statement/ Management Account (past 1 year)
- Credit Bureau Statement (past 1 month) of Personal Guarantor(s)
- Notice of Assessment (past 1 year) of Personal Guarantor(s)
*Required application documents may vary on application based on the financing request