Which should I choose: invoice factoring or invoice discounting?

Waiting weeks or even months for invoices to be paid can put pressure on any businessʼs cash flow. When your money is tied up in unpaid invoices, it can be difficult to cover operational costs or invest in growth opportunities. Itʼs a common problem, with 52% of UK SMEs experiencing this issue, according to the Federation of Small Businesses. 

Invoice finance is an umbrella term for similar types of finance that release the revenue locked up in unpaid invoices. In this article, weʼll look at the two most commonly used forms of invoice finance: invoice factoring and invoice discounting. This kind of debt finance can be used to cover cash flow gaps left by money owed to you.

The main ways factoring and discounting differ has to do with who controls the sales ledger, and whoʼs responsible for collecting payments and chasing unpaid invoices. They offer alternative finance options to more traditional choices such as loans and credit cards. Weʼll break down everything you need to know about both options, helping you to decide which one might be right for your business.

How invoice finance works:

• You invoice your customer/client

• You give the invoice details to the finance provider

• A percentage of the invoice is paid to you, typically within two days

• Either you chase the outstanding invoices or the finance provider does it for you

• When your customers/clients pays, the rest of the value of the invoice is paid to you, minus the finance providerʼs service fee

Key points:

• Invoice factoring releases money tied up in unpaid invoices and outsources the hassle of chasing payment

• Invoice discounting also gets you access to your money quicker, but the work of getting invoices settled stays with you

• Funding Options by Tide can help when optimisation of working capital isnʼt enough, offering access to business finance up to £20 million

What is invoice factoring?

With invoice factoring, the finance provider advances you most of the invoice value (typically around 75-90%) within just a few days, then takes responsibility for chasing payment from your customers. It can be useful for smaller businesses who donʼt have a big credit control team. As customers will partly have to deal with a third party, itʼs worth considering how this might affect your customer relationships.

Advantages

• Immediate cash flow relief: Get money from sales within days rather than weeks or months

• Credit control handled for you: The factoring company chases payments, freeing up your time

• Accessible finance: Lenders focus more on your customersʼ ability to pay than your own credit history

• Predictable cash flow: Can help with financial planning and budgeting

Disadvantages

• Higher costs: Youʼre essentially paying to outsource credit control and sales ledger management

• Less confidential: As theyʼll deal directly with the provider, your customers will know youʼre using factoring

• Potential customer concerns: Some clients may want to deal with you directly

• Comprehensive commitment : Usually requires you to factor all or most of your invoices

What is invoice discounting?

Invoice discounting provides similar cash flow benefits to factoring but with one key difference: you retain complete control over your sales ledger and customer relationships. The finance provider advances you money against your invoices, but your customers continue to pay into an account bearing your business name, often without knowing that youʼre using invoice finance.

Advantages

• You maintain customer relationships: You keep full control over customer interactions

• Lower costs: Generally cheaper than factoring since you handle your own credit control

• Complete confidentiality: Your customers typically donʼt know youʼre using invoice finance

• Flexibility in customer management: You can tailor your approach to different customers

Disadvantages

• Higher business requirements: Usually only available to more established businesses with turnover above £100,000

• Credit control retained: You must handle all debt collection and customer relationship management

• Personal guarantees often required: Lenders might require directorsʼ personal guarantees

• Stricter qualification criteria: Tougher eligibility requirements based on your businessʼs financial strength and credit control procedures

What are the key differences? 

The fundamental difference between these two types of cash flow loan comes down to control and responsibility. One other aspect to keep in mind is that discounting is cheaper than factoring, reflecting the extra work the finance provider has in chasing payment. 

Example 1: A small agency using invoice factoring

Sarah runs a digital marketing agency with five employees. She invoices clients monthly but often waits 60-90 days for payment. With limited resources for credit control, she chooses invoice factoring.

• Sarah invoices Client A for £5,000 worth of services

• The invoice is sent to the factoring provider on Monday

• By Wednesday, £4,000 (80%) is in the company business account

• The factoring company contacts Client A directly about payment

• Client A pays the factoring company after 45 days

• Sarah receives a further £850, minus a 3% factoring fee of £150

• Total received: £4,850 from a £5,000 invoice

Example 2: Established manufacturing business using invoice discounting

James owns a manufacturing company with £2 million annual turnover and a dedicated accounts team. He chooses invoice discounting to maintain customer relationships while improving cash flow.

• James invoices Client B for £20,000 worth of manufactured goods

• He provides invoice details to his discounting provider

• Within 24 hours, £16,000 (80%) is advanced to his business

• Jamesʼs accounts team follows up on payment as usual

• Client B pays into an account bearing Jamesʼs company name (but managed by the provider)

• James receives the remaining £3,700 (minus a 1.5% discounting fee of £300)

• Total received: £19,700 from a £20,000 invoice

Which option fits your business size and credit profile?

Choosing between invoice factoring and discounting largely depends on your businessʼs size, resources, and specific circumstances. Hereʼs a framework that might help you decide:

Credit profile considerations:

With invoice factoring, providers focus more on your customersʼ creditworthiness than your own. This makes factoring accessible for businesses with limited trading history, less-than-perfect credit scores, or smaller financial statements.

For invoice discounting, providers scrutinise both your businessʼs financial health and your customersʼ payment reliability. Youʼll typically need strong business credit history, proven debt collection capabilities, solid financial statements, and an experienced management team

Mixed approaches:

Some businesses benefit from hybrid solutions, depending on your situation:

• Selective invoice finance: Choose specific invoices or customers to finance

• Spot factoring: Finance individual invoices on an ad-hoc basis

• Confidential factoring: Some providers offer factoring with greater customer confidentiality

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Checking if youʼre eligible is free, only takes a few minutes, and while a full application would impact your personal or business credit score, checking eligibility wonʼt. Just submit your details via the link below to find out if you could be eligible to borrow up to £20 million.

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FAQs

How much does invoice factoring cost compared to invoice discounting?

Invoice factoring typically costs between 2-5% of the invoice value, while invoice discounting usually ranges from 1-3%. The exact cost depends on factors like your industry, customer payment history, and the level of service you're looking for. Factoring costs more because you're paying for credit control and debt collection services, whereas with discounting these responsibilities stay with you.

What percentage of my invoice value can I access immediately?

Most providers will give you 70-90% of your invoice value upfront. The amount depends on your industry risk profile, customer creditworthiness, and the providerʼs assessment of your business. Higher-risk industries or customers with poor payment histories might receive lower advance rates.

How quickly can I access funds after submitting an invoice?

With both factoring and discounting, you can typically get the funds within 24-48 hours of sending an  invoice to your provider. Some offer same-day funding for established clients. The speed often depends on when you send invoices to them and your providerʼs processing procedures.

Can I choose which invoices to factor or discount?

Traditional factoring and discounting agreements usually require you to include all eligible invoices. But selective invoice finance and spot factoring allow you to choose specific invoices or customers. These selective options might have higher fees but offer greater flexibility.

What happens if my customer doesnʼt pay their invoice?

With invoice factoring, the provider typically handles non-payment issues and might offer credit protection insurance. With invoice discounting, you remain responsible for bad debts unless you have specific credit insurance. Most agreements mean you might need to buy back invoices if customers donʼt pay by a certain date.

Will using invoice finance affect my relationship with customers?

With invoice factoring, your customers will deal directly with the finance provider, which, depending on the providerʼs professionalism, could affect relationships. Invoice discounting is confidential, so customers typically donʼt know youʼre using it. The impact on your customer relationships largely depends on your choice between the two options and the quality of service from the provider.

What are the minimum eligibility requirements to qualify for each option?

Invoice factoring requirements are generally more flexible, often accepting businesses with turnover from £50,000 annually and limited trading history. Invoice discounting typically requires annual turnover of at least £100,000-£250,000, established trading history, robust credit control procedures, and strong financial management systems.

Can I switch from factoring to discounting (or vice versa) later?

Many providers offer both services and can let you switch between the two as your business grows and evolves. However, youʼll typically need to meet any minimum contract terms with your current provider. The provider will look at your current needs, creditworthiness, and operational capabilities before deciding if they’ll let you switch.

How do contracts work and can I exit early?

Most invoice finance agreements include minimum contract periods – often 6-12 months – and notice periods for ending the agreement. Some providers offer more flexible terms, particularly for established businesses. Any early exit might incur penalty fees, so itʼs worth understanding termination clauses before signing any agreement.

What documents and information do I need to provide to get started?

Both options typically require business registration documents, recent financial statements, aged debt reports, bank statements, and details about your customer base. Invoice discounting might require information about your credit control procedures and management experience. The specific requirements vary between providers, but expect a thorough assessment of your businessʼs financial health and operational capabilities.

Please note that the information above is not intended to be financial advice. You should seek independent financial advice before making any decisions about your financial future.

Itʼs important to remember that all loans and credit agreements come with risks. These risks include non-payment and late-payment of the agreed repayment plan, which could affect your business credit score and impact your ability to find future funding. Always read the terms and conditions of every loan or credit agreement before you proceed. Contact us for support if you ever face difficulties making your repayments.

Funding Options, now part of Tide, helps UK firms access business finance, working directly with businesses and their trusted advisors. Funding Options are a credit broker and do not provide loans directly. All finance and quotes are subject to status and income. Applicants must be aged 18 and over and terms and conditions apply. Guarantees and Indemnities may be required. Funding Options can introduce applicants to a number of providers based on the applicantsʼ circumstances and creditworthiness. Funding Options will receive a commission or finderʼs fee for effecting such finance introductions.