Invoice Factoring vs. Invoice Discounting: Find the Best Option for Your Small Business

Posted by Factor Funding Co. on January 24, 2012

Many small businesses suffer from immediate cash flow problems. While these issues can cause a company to collapse they don't have to be the end of your business. If you're a small business owner you might be able to free up some of your pending income by using either invoice factoring or invoice discounting. Both programs can improve your company's bottom line but you'll need to consider your specific business needs when you're deciding which method to use.

About Invoice Factoring

Put simply, invoice factoring is when you sell your accounts receivable to a third-party company in exchange for immediate cash. The major benefit of this program is that it allows you to receive cash right away rather than waiting on your customers to remit their payments. The invoice factoring company will take a cut of the outstanding payments as a transaction fee and send you the remaining amount within a week or two. The company will then assume responsibility for collecting the receivables.

Invoice Discounting Overview

Invoice discounting, on the other hand, is a short-term loan based the value of your company's account receivables. Rather than selling the receivables outright, you use them to qualify for a loan and then repay the loan after you collect the outstanding receivables yourself. If you use invoice discounting you'll pay a small fee for the transaction as well as an interest rate on the loan.

How Factoring and Discounting Compare

Invoice factoring and invoice discounting are similar in that both methods use your account receivables to improve your cash flow. Both programs allow you to receive cash from your outstanding invoices immediately. However, there are significant differences between the two methods. Invoice factoring is not a loan while invoice discounting is. When you perform invoice factoring you are selling your receivables outright to the factoring company. This means that the factoring company will become responsible for collecting on the outstanding invoices. Invoice discounting, however, allows you to keep more of your money since the fees are lower for this method than they are for invoice factoring. But if you do invoice discounting you will still be responsible for collecting the payments and repaying the loan.

Potential Concerns

Both invoice factoring and invoice discounting have pros and cons. For example, since the factoring company has no relationship with the customers the methods they use to collect the outstanding balances may not be friendly enough to keep your customers happy with your services. Invoice discounting, which requires you to pursue the outstanding balances yourself, is less expensive but may present too much work for a business with a small collections department.

When your small business needs quick cash both invoice discounting and invoice factoring can provide assistance. Make sure to compare invoice factoring vs. invoice discounting before you commit to either program.

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