For any company that needs to raise money, using outstanding customer invoices as collateral is a quick and convenient way of doing it. The process is simple, and most companies will qualify to borrow money in this way.
There are several different asset-borrowing products available, but the most commonly used are invoice factoring or discounting. These products allow a firm to take one or several of a customer’s invoices and borrow up to 90% of the face value of that invoice. When the customer pays their invoice, the debt is paid off and the balance – minus interest and any charges – is credited to the account of the firm that raised the invoice in the first place.
Both products are very similar, but there are important differences. It is important for any company considering borrowing money in this way to understand the difference in order to choose the best product for its individual circumstances.
The main differences
The most important difference between the two products is who has control of making sure that the invoices are paid. In other words, who has control of the sales ledger.
With factoring, the agent making the loan is the one who collects the money. On the other hand, with invoice discounting, the firm borrowing the money is responsible for collecting the cash owed by its customers. The other key difference is that with factoring, it is possible to take out insurance to cover the debt should any invoices remain unpaid.
Some companies charge different fees for factoring than they do for invoice financing. In addition, there can be a difference in how much can be borrowed against each invoice.
Deciding between the two products
Which product is right depends a great deal on the individual circumstances of the firm wanting to borrow money. Typically, larger companies that have a full accounts team choose to retain control of their sales ledger and carry out their own credit control. Most large companies already have sufficient staff with the right expertise to chase up customers and make sure that they pay all outstanding invoices on time.
For smaller firms, factoring is often the better option. It is far easier for them to let the factoring agent chase up any late payers. This allows small business owners to focus on their core business rather than wasting time dealing with credit control.
However, sometimes even small firms prefer to opt for invoice financing. Often, they do so because they do not want their customers to know that they are having to borrow money. It is a personal decision, but in some situations it is wiser not to let customers know that a firm is having to borrow money. Some customers may take advantage and ask for excessive discounts if they think a company they are buying from is in a tight spot, financially.
The best of both worlds
Some firms use both methods to borrow money. They use factoring to borrow against some customers invoices. However, for customers with whom they have a delicate relationship they use invoice financing instead.