Many companies who have exhausted traditional options for financing are looking at factoring or discounting invoices as alternative methods. Note that these two are not one and the same. This article will explain some of the differences as well as mention some items to consider when deciding whether or not to enter a discounting arrangement.
Invoice discounting usually refers to an arrangement where a company opens up a credit line with a third party using its receivables as collateral. The company can usually borrow up to 80 or 90 percent of the face value of their receivables. Note that the company doesn’t have to borrow that much if it doesn’t want or need to. There is usually an interest charge and a service charge involved in these arrangements.
Factoring usually refers to the actual sale of an invoice to a Factor (a third party who buys companies’ accounts receivable). Under these agreements the Factor will usually pay the company anywhere from 60 to 90 percent of the value of the invoice upfront. The Factor will then collect the money from the company’s customers and remit the remaining amount minus the fee to the company.
Items to Consider
In an invoice discounting relationship, your company can decide how much it wants to borrow. In a factoring relationship you sell the entire invoice to the Factor; you can’t sell half an invoice.
In a discounting relationship your company collects payments from your customers. This is good if you want to be the one interacting with your customers. In addition, customers usually don’t like having their invoices or contracts being sold to someone else (even if it is a perfectly legal and ethical move, it just seems wrong to interact with one company and then have to make payments to a separate company). On the other hand it can be a real time and money saver to have someone else collecting your invoices for you. This can free up time for you to work on your core competencies. You’ll just have to look at your company’s long term strategy and decide which is a better fit.
You’ll also want to consider whether you can find a less expensive form of financing. Whether you are factoring or discounting, these are usually considered short term solutions.
One other item you will want to consider is whether you are entering into a recourse or non-recourse factoring agreement. In a non-recourse agreement the Factor completely owns the invoice and does not owe anything back to the company who sold the Factor the invoice.
Factoring and discounting can be a good short term solution, but you’ll definitely want to do your homework before entering into one of these agreements. In addition, you’ll want to seek the help of a professional lender or investor.