Invoice discounting and invoice factoring offer financing based on your accounts receivable. Both products offer similar benefits to client. While there are similarities between these products, there are also a number of important differences.
This article helps you understand the main differences between factoring and invoice discounting so that you can make an educated choice between the products.
Individual vs. batch financing
Invoice factoring facilities finance invoices individually. Each invoice is ledgered and tracked individually. When a customer makes a payment, the payment is applied to a specific invoice, which settles the invoice. This method makes the accounting reconciliation process fairly straightforward.
Invoice discounting facilities, on the other hand, finance invoices in a batch using only aggregate values. Invoices are not ledgered or tracked individually. Instead, customer payments are applied to the total outstanding amount. Clients must reconcile payments directly in their own ledgers as part of their internal settlement process.
Invoice factoring facilities are better suited for smaller clients. Generally, these companies may not have the staff and resources to have fully implemented accounting controls. On the other hand, invoice discounting facilities are better suited for companies that have credit controls, financial controls and internal audit procedures in place.
Most factoring programmes finance individual invoices. As part of the financing process, the financier verifies a large sample of invoices to ensure they are accurate and payable by the due date. Verifications are done by the financier as part of the financing and collections process.
As mentioned before, invoice discounting finances invoices as a batch. The financier does not track or verify individual invoices, as collections and credit management activities are left to the client. However, some financiers will spot-check specific invoices that are above a certain value or meet certain criteria.
Most factoring companies rely on notification letters to inform your customers of the financing relationship. The letter advises customers that a factoring company is financing your receivables and managing collections. These letters are not sent for invoice discounting lines.
One area in which invoice factoring and invoice discount are similar is the handling of payments. In both cases, payments flow through the debtor finance company, who settles the line and remits any excess reserves back to the clients.
However, the process to notify clients of the new payment method varies for both products. The invoice discounting payment collections process omits any references to the financier.
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