Invoice discounting vs factoring: which suits your business?

Invoice discounting vs factoring comes down to one question: who collects the money from your customers? Both are forms of invoice finance. In each, a provider advances most of the value of your unpaid invoices and pays the rest, less its charges, when your customer pays.

• Factoring. The provider runs your sales ledger, chases payment and collects it. Your customers pay the provider and know the arrangement exists.
• Invoice discounting. You keep running the sales ledger and chasing payment. The facility is often confidential, so customers carry on dealing with you as normal.

Lenders' own descriptions follow this split. Aldermore Bank says that with invoice discounting the business stays responsible for collecting payment, so the facility can remain confidential, while with factoring it provides credit control and collects payments, so customers are aware. Our invoice finance guide explains the product family as a whole.

The cost line is a general pattern, not a published rate. Providers price each facility individually, typically with a service fee and a discount charge on the money you draw, and neither varies only with the product type. Ask every provider for the total annual cost on your expected turnover.

Most providers publish an upper limit on the advance, not a fixed figure. What you get depends on your customers, your sector and the quality of your sales ledger.

• Aldermore Bank publishes up to 90% of invoice value for both invoice discounting and factoring.
• Bibby Financial Services publishes typically up to 85% of invoice value for both its factoring and its confidential invoice discounting, and says the amount depends on sector, debtors and other factors.
• eCapital (UK) publishes an advance of up to 90% on invoice discounting and up to 80% on selected invoices through selective invoice finance.
• Team Factors publishes an advance of up to 90% on its factoring facility, with facilities up to £1.5 million.

The rest of each invoice, less charges, is released when your customer pays. If customers pay slowly, the money stays tied up longer and charges run on. Our page on debtor days and creditor days shows how to measure how quickly you are paid.

Invoice discounting generally asks for more, because the provider is trusting you to collect. Aldermore, for example, says it generally looks for a minimum turnover of £750,000 and that invoice discounting suits businesses with an in-house credit control department. eCapital describes its invoice discounting as suited to established SMEs with strong credit control processes.

Factoring has a lower bar because the provider runs collections itself, which is why it is common among smaller and newer businesses. Some providers fund invoice by invoice with no whole-ledger commitment: Penny offers spot factoring on invoices of £500 to £500,000 to sole traders and limited companies, and confidential invoice discounting to limited companies only.

Whichever you choose, expect a provider to look at:

• Who your customers are, and whether they are businesses or public bodies.
• How spread your sales are, and whether one customer dominates.
• Your aged debtor report, disputes and credit notes.
• Whether your invoices are for work already done, or for stage payments and contracts in progress.

Whole-ledger factoring and discounting facilities usually run for a set period with a notice period to leave. Aldermore says its contract length is negotiable; other providers set their own terms. Check these before you sign:

• Minimum term and notice period. How long you are committed for and what it costs to leave early.
• Minimum fees. Some facilities charge a minimum annual fee whatever you draw.
• Recourse. On a recourse facility, if a customer does not pay, you bear the loss. Partnership Invoice Finance, for example, says its factoring is on a recourse basis.
• Bad debt protection. An optional add-on at several providers, including Aldermore and Team Factors, that covers losses where a customer cannot or will not pay.
• Personal guarantees and indemnities. Many facilities ask directors to guarantee or indemnify the provider. Read our page on personal guarantees.

Usually not, for smaller suppliers. The Business Contract Terms (Assignment of Receivables) Regulations 2018 say a term in a contract for goods or services has no effect to the extent it prohibits or restricts the assignment of a receivable. They apply to contracts entered into on or after 31 December 2018.

The rule does not help every business. It does not apply where, at the time of the assignment, the supplier is a large enterprise or a special purpose vehicle. A supplier that is small or medium-sized under the Companies Act tests generally falls within it. Ask the provider, or a solicitor, if a major customer's contract restricts assignment.

If the issue is customers paying late rather than a need for working capital, deal with that first. GOV.UK says businesses can claim statutory interest on late business-to-business payments of 8% plus the Bank of England base rate, unless the contract sets a different rate. Our guide to late payment interest explains how to claim it. Larger businesses with stock and plant as well as debtors may also look at asset-based lenders.

To see each provider's published terms, browse our lender directory or check your funding options. More guides are in our types of finance section.