Factoring vs Invoice Discounting

by Michael Russell

Both factoring and invoice discounting can be described as ways to get
immediate cash by selling accounts receivable to a third party, usually a
finance company. In fact, the two methods are more similar than they are
different.

Factoring, also referred to as asset securitization, is an outright sale of
receivables to the finance company. The business gets cash and the finance
company collects the debt, keeps the interest and gets a discount fee on top of
that for its trouble. Invoice discounting can also be termed a sale of
receivables, but in this case administration of the receivables and their
collection does NOT change hands. The business that earned the income still
holds that responsibility.

Here are some questions to consider in order to choose which method is best
for your company:

1. Are you concerned with the cost of collections in your company? Are they
getting out of hand? Is your collections area fully staffed with competent and
reliable personnel? If you think your company would be better off reducing the
amount of resources devoted to this function, factoring is the better choice for
you, as a lot of it, but not all, can be offloaded to the finance company. If
you already have a well-working collections department you might rather choose
invoice discounting. That way your staff and procedures regarding collections
remain in place.

2. Knowing that the finance company will undoubtedly treat your customers
with the utmost courtesy, respect and professionalism, are you nevertheless
concerned that he may prefer to be dealing directly with your company? Perhaps
billing requests often come together with customer service requests. Your
customer is generally not aware of the sale of his receivable to you with
invoice discounting. Not only is he aware of a factoring arrangement, but also
he is subject to confirmation calls on individual invoices by the finance
company on occasion. If this is something you know would disturb your customers
you may need to choose invoice discounting.

3. What are your current informational needs with regard to collections
efforts and your customers? Do you currently collect this data and rely on it to
make future credit decisions for this customer? Can the finance company provide
it in the format and frequency you desire? If not, invoice discounting may be
the right choice, so all your current data collection techniques will not be
disturbed.

4. What are your cash requirements? With either factoring or invoice
discounting, you are paying for the immediate cash. Doing the collections
yourself at a normal rate would return you more actual cash. But invoice
discounting returns you more cash than does factoring. This is, obviously,
because the finance company takes on more responsibility and more duties with
factoring than with invoice discounting.

5. How large a portfolio of unsecured receivables does your company hold? How
diverse is it? Are there any single customers who hold more than 20% of the
total receivables balance? Generally, companies using invoice discounting tend
to be larger and have a more diverse portfolio. This could be why they chose
invoice discounting, however, rather than a characteristic. They already have
the collections efforts and data collections methods in place and the cost and
difficulty involved in changing them might be prohibitive for a factoring
arrangement. Diversity in the portfolio is something finance companies look for
under both arrangements.

Making an honest assessment based on these factors will allow you to make the
right choice for your company. You’ll soon be on the way to a healthy cash flow,
no matter which you choose.

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