Know Your Financing Options: Invoice Factoring vs. Invoice Discounting

The MSME sector shelters around 63 million enterprises that contribute 30% to India’s GDP, 45% to manufacturing, 40% to exports, and employ over 113 million people. MSMEs across the globe are now climbing the ladder of success, owing to the financial aid made easily accessible to them by new-age NBFCs and banks.

The financial aids are designed to help businesses streamline their cash flow, sail through market fluctuations and other challenges, as well as thrive in competitive industries by seizing every growth opportunity. Two of the most significant financing tools that are driving growth for MSMEs today are invoice factoring and invoice discounting in India. Businesses can best prepare to address financial challenges by leveraging these key aids.

Invoice factoring and invoice discounting both bring a host of benefits for businesses that need immediate financial solutions to optimize their cash flow. However, they often must face the dilemma of invoice factoring vs. invoice discounting, given that there are certain similarities; for example, both financing methods involve the use of invoices to improve liquidity.

Getting familiar with the differences between these two options can help businesses make informed decisions based on their specific financial position, credit history, and immediate needs. Before deciding on the financing solution, it is important to understand the specific purpose that each option serves, and what factors set them apart. In this blog, we will explore the key differences between factoring and invoice discounting.

Factoring vs. Invoice Discounting – The Key Differences

Before delving into the differences, let us take a closer look at both options individually, starting with what invoice factoring is in trade finance. Invoice factoring, also known as accounts receivable factoring, is a financial arrangement where a business sells its outstanding invoices to a third-party factoring company.

In return, the business receives immediate cash, typically around 70% to 90% of the invoice value, and the remaining amount (minus fees) upon the customer’s payment. The factoring company assumes the responsibility of collecting the payment from the customers at invoice maturity. This method helps businesses bridge the cash flow gap caused by delayed payments and allows them to meet their immediate financial needs.

Invoice discounting is a financing arrangement in which invoices are used as collateral to receive a short-term loan that must then be repaid. In an invoice financing arrangement, a financial intermediary advances the bulk (up to 95%) of the invoice amount upfront. When payment is submitted by the buyer at invoice maturity, the business then repays the financier.

The main difference between invoice factoring and invoice discounting is related to the collection process. In invoice factoring, the factoring company is responsible for the collections. This involves tasks such as invoice verification, credit control, and debt recovery. It enables the business to focus on revenue-generating tasks instead of administrative ones. In invoice discounting, the business must take care of the collections, maintaining good relations with customers, while also ensuring improved cash flow.

In terms of eligibility, invoice factoring is a more ideal solution for SMEs, including those with limited credit histories. The factoring company’s decision is primarily based on the creditworthiness of the business’s customers, as they are the ones responsible for payment. Invoice discounting is used by larger companies with recurring invoices and who are in need of larger volumes of funds.

Another important difference is associated with the degree of confidentiality. With invoice factoring, the customers of the business know of the factoring company’s involvement in the payment process. This transparency does not always work in the favor of the business as it may raise concerns among customers regarding the business’s financial stability.

Whereas, invoice discounting is a confidential arrangement where customers remain unaware of the business’s financial arrangement with the lender. This can be an advantage for businesses that prioritize maintaining strong relationships with their customers.

There are certain differences when it comes to the cost structures of invoice factoring and invoice discounting as well. With invoice factoring, the fees can range from 1% to 5% of the invoice value. Factoring companies build the fee structure based on the volume of invoices, the creditworthiness of the customers, and the length of time the invoices are outstanding.

With invoice discounting, the charges are usually in the form of interest on the borrowed amount, which is generally on the higher side as compared to invoice factoring fees. The interest rates depend on several factors such as the business’s creditworthiness, the quality of invoices, and prevailing market conditions.

Tradewind Finance – Excellent Invoice Financing Solutions in India 

Aspire to accelerate business growth? Begin your journey to success with Tradewind Finance. We are one of the leading international trade finance companies with over 180 employees working from 20 offices located in 12 countries. Our highly trained staff offers world-class customer service and truly understands global trade.

We specialize in cross-border transactions globally for sales made on open accounts, letters of credit, and documentary collections payment terms. Using purchase order funding, inventory lending, letters of credit, and structured guarantees, our financing helps align the needs of both buyers and sellers. Our solutions are offered in multiple currencies, eliminating the risks of currency exchange.

We solve short-term cash flow issues by purchasing your company’s accounts receivable in exchange for an advance of up to 95% of the total invoice value. Then, we collect the full amount from your client upon invoice maturity. Once the invoice is paid in full, we send you the remaining balance. In addition to factoring your export accounts receivable, we can also finance your full supply chain.

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