It's tough to get your invoices paid faster, especially when the company you're invoicing is bigger than you are. Discounting is a solution that entices your customers to pay their invoice faster, and Factoring skips the whole problem by paying you immediately.
- Factoring an invoice involves you selling the ownership of an invoice. The factoring company owns the asset after you sell it for agreed upon contract terms.
- Typically, you receive 70-80% of your invoice value upfront, right away. The 20-30% is held as Reserve and paid to you, minus fees, after the Account debtor (your customer) pays the Factoring company.
- The fee amount is determined by the factor, and agreed upon by the client, based on a number of variables including the payment history, customer list, operating history, size of Account, debtor and many others. Fees usually start at 1% and rise from there.
- Many factoring companies have various other fees such as late charges, wiring fees, application, minimum monthly account balance fees, and more. Make sure you understand all possible fees before entering into an agreement.
- Also note if your credit is pulled, you have to sign a personal guarantee and other stipulations.
- Spot or Selective factoring is a form of factoring where you can select which invoices will be factored. Most factoring companies require you to factor all of your invoices, and many times keep a minimum balance. Spot factoring is not standard practice, most traditional factors require that you factor all of a customer’s invoices going forward.
- Invoice discounting involves offering a discount to an invoice’s payor to incentivize them to pay faster
- A discounting program can be run by the company/vendor/supplier (oftentimes manually) or a 3rd party can be used.
- Discounts offered are usually between 1-5% depending on how quickly payment is requested On top of this, costs can grow as your team spends time for communication, updating invoices, and redoing any cash application. There may be additional fees charged by the 3rd party discounting service if you’re using one.
- There are 3rd party discounting services that offer you a loan based on outstanding invoices, which provides immediate cash flow. This is very similar to a Factoring structure where the amount of debt offered is usually 70-80% of the invoice’s value. The difference is who has ownership of the invoice itself. When ownership does not change then, upon repayment of the invoice, the business repays the lender the advance amount, plus a fee/interest.
It’s relatively easy to predict who banks are willing to fund. They turn away high growth businesses with a lack of financial history, or where a business model is poorly understood because the model falls outside of their risk parameters. High-growth, high-margin, businesses are prime candidates for invoice factoring or invoice discounting. So are manufacturers, wholesalers, staffing, marketing, and companies in many other industries. Both solutions offer a cash flow solution for those outside of traditional banking solutions. Both are leveraging an asset (your outstanding AR) to solve your cash flow problem.
A factoring solution will always provide you with an advance upfront, whereas a discounting solution will not. Factoring sells one or more outstanding invoices to a Factoring company, whereas if you receive an advance from a discounting company you are getting a loan which will impact your credit.