Invoice Finance vs Factoring: What's the Difference?

The terms 'invoice finance', 'factoring', and 'invoice discounting' are often used interchangeably in the market, which creates confusion. Here is the clear distinction: invoice finance is the umbrella term for all products that release cash against unpaid invoices.

Within invoice finance, there are two main variants - invoice factoring (also called factoring) and invoice discounting. The core difference between them is who manages the collection of payment from your customers.

In a factoring arrangement, the business sells its invoices to the factor (the finance company) and the factor takes over responsibility for collecting payment from the debtor (the customer). The process runs as follows: the business raises an invoice and notifies the factor; the factor advances 80-90% of the invoice value, typically within 24 hours; the factor sends a notice of assignment to the customer, advising them that the invoice has been assigned and payment should be made directly to the factor; when the customer pays, the factor releases the remaining 10-20% balance, minus its fees.

Your customers know you are using a factoring facility because the notice of assignment reveals the factor's involvement. This is the defining characteristic of factoring - it is a disclosed arrangement. Some businesses are concerned about what customers will think; in practice, factoring is widely used and well understood by most B2B businesses, and it is rarely a commercial impediment.

Factoring charges consist of two components: a service fee (typically 0.5-3% of the invoice face value per month, covering the administration and credit control service) and a discount charge (interest charged on the advanced funds at an annual rate of typically 2-8%, applied daily from the advance date to the date of repayment).

Factoring is generally slightly more expensive than invoice discounting because the factor provides a credit control service as part of the package.

Factoring is typically best suited to businesses that are earlier in their growth, do not have a dedicated credit control function, want to outsource the administrative burden of chasing debtors, or have customers with variable payment reliability.

It is also well suited to businesses with adverse credit profiles, as the factor's underwriting focuses on the customers' creditworthiness rather than the business's own.

Invoice discounting operates on the same basic principle - cash is released against unpaid invoices - but the business retains control of its own credit control function. Customers are unaware of the facility and continue to pay the business directly, as they always have. The business collects payment into a dedicated trust account (or its own account, depending on the lender), from which the advance is automatically repaid.

Because the customer relationship and payment collection remain entirely with the business, invoice discounting is a confidential facility - typically referred to as Confidential Invoice Discounting (CID). This is its primary advantage over factoring: customers experience no change in their relationship with the business.

Invoice discounting is typically slightly cheaper than factoring because the business handles its own credit control, reducing the lender's workload. The service fee is typically 0.2-1% of invoice value per month, and the discount charge typically 1.5-5% per annum.

Invoice discounting typically requires a more established business than factoring. Most invoice discounting lenders require minimum annual turnover of £500,000 and the business to have an internal credit control function capable of managing debtor collection effectively.

For businesses that meet these criteria, discounting offers the cash flow benefit of invoice finance without any of its visibility to customers.

Both factoring and discounting can be structured on a whole-ledger or selective basis. Whole-ledger facilities cover all eligible B2B invoices.

Selective (or spot) invoice finance allows the business to choose which specific invoices to finance - useful if only certain customers or certain invoice sizes drive the working capital pressure. Selective finance is typically more expensive per invoice but gives flexibility to businesses with mixed debtor profiles.

Recourse factoring: if a customer does not pay (other than due to insolvency), the business must repurchase the unpaid invoice. The business carries the bad debt risk.

Non-recourse factoring: the factor absorbs the loss if a customer becomes insolvent. The factor conducts credit checks on your customers and sets credit limits; invoices within those limits are covered. Non-recourse factoring provides genuine bad debt protection and is more valuable for businesses supplying financially volatile customers, though it typically carries a higher service fee.

Initial setup typically takes 5-10 working days. The lender will conduct due diligence on the business, its debtors, and its invoicing processes - checking that invoices are genuine, undisputed, and unconditional (not subject to retention clauses or conditional payment terms).

Once live, advances against individual invoices are typically processed within hours of notification. The facility is revolving and grows automatically as invoicing volumes increase, making it one of the most scalable working capital products available.

Invoice finance works for almost all B2B businesses. Consumer-facing businesses (B2C) where invoices are not raised are not eligible for standard invoice finance, though some specialist products exist for recurring consumer subscriptions.