Overview

Invoice discounting and factoring are two common ways to unlock cash tied up in accounts receivable. Both accelerate cash flow, but they split control, cost, and risk differently. Understanding those trade-offs helps you pick the option that fits your business needs.

How each option works

  • Invoice discounting: A lender advances a percentage of your outstanding invoice value (commonly 70–90%). Your company keeps managing sales ledger and collections; once customers pay, you receive the remainder minus fees. This is usually structured as a confidential facility, so your customers may not know you’re borrowing (see examples and use cases at FinHelp: “Using Invoice Discounting for Short-Term Liquidity” – https://finhelp.io/glossary/using-invoice-discounting-for-short-term-liquidity/).

  • Factoring: You sell invoices (in full or in part) to a factoring company. The factor pays an advance and takes responsibility for collecting the invoices. Factoring can be disclosed or undisclosed, and depending on the agreement it may be recourse or non-recourse (see FinHelp coverage: “Invoice Factoring vs Invoice Discounting: What’s the Difference” – https://finhelp.io/glossary/invoice-factoring-vs-invoice-discounting-whats-the-difference/).

Control and customer relationships

  • Control: Invoice discounting preserves the most operational control because your team continues collections and customer communications. Factoring hands collections to the factor, which can change how customers experience billing and support.

  • Customer perception: Factoring (especially disclosed factoring) may signal third‑party collection involvement and can affect customer relations. Confidential invoice discounting avoids that.

Costs, fees, and advance rates

  • Fees: Factoring fees often appear higher because they combine an advance fee, ongoing service fees, and sometimes additional collection charges. Invoice discounting usually functions like a borrowing facility (interest + facility fees) and can be cheaper for companies with strong credit and reliable payers.

  • Effective cost: Compare factor rates, interest rate, draw fees, and minimum monthly fees. Convert nonstandard fee structures into an annual percentage cost to compare offers accurately (see FinHelp: “How to Compare Factor Rates and APR on Short‑Term Business Credit” for methodology).

Risk and balance-sheet treatment

  • Accounting: Invoice discounting is typically treated as a secured borrowing and leaves receivables on your balance sheet. Factoring—if it qualifies as a sale—can remove receivables from your books, improving certain leverage ratios but changing reported revenue and liquidity.

  • Credit risk: With recourse factoring, you may remain liable if a customer doesn’t pay. Non-recourse factoring shifts credit risk to the factor but usually costs more.

Who should choose which

  • Invoice discounting fits: Established businesses with strong internal credit control, confidential financing needs, and a desire to preserve customer relationships.

  • Factoring fits: Growing or early-stage companies that need immediate cash quickly, have less-developed credit-control functions, or prefer to outsource collections.

Practical comparison checklist

  1. Ask for advance rates and all fees in writing (advance percentage, discount or factor fee, service fees, reserve release schedule).
  2. Request a sample agreement and check for recourse/non-recourse clauses and customer-notification requirements.
  3. Model cash flows: run a 12-month projection showing net cash from each option after fees.
  4. Consider operational impact: who will handle disputed invoices, returns, or customer service? Factor or lender policies should be clear.

Professional tips from practice

  • I advise clients to get at least three written quotes and to convert every fee into an annualized cost before deciding. Small differences in fee structure compound quickly.
  • Negotiate reserve-release timing. Faster reserve release reduces working-capital drag.
  • If customer relationships are strategic, prioritize confidential invoice discounting or an undisclosed factoring arrangement.

Common mistakes and misconceptions

  • “Factoring is only for failing firms”: false. Many growth businesses use factoring to fuel expansion.
  • “Invoice discounting is always cheaper”: not always—smaller companies with weaker credit profiles may pay more for confidential facilities than they would for factoring.

Sources and further reading

Disclaimer

This article is educational and not individualized financial advice. Terms, costs, and accounting treatment vary; consult your accountant or a commercial finance adviser to review contract terms and tax or balance-sheet implications before signing.