Factoring vs Invoice Discounting

Explains how Invoice Discounting differs from Factoring

Invoice Discounting can be described as the provision of finance against the security of receivables and in this respect is similar to factoring. The major differences is that the facility is confidential i.e. the customer is unaware of the facility and the supplier is responsible for the sales ledger administration.

Invoice discounting can only be provided where goods or services are supplied business to business on credit terms. Bad debt protection may be included in the facility if required.

The criteria for obtaining an invoice discounting facility is higher than for factoring and the service provider will be influenced by the following:
a) The quality and quantity of customers with particular attention to the spread. Ideally no one customer’s balance outstanding should be more than 20% of the total debts outstanding.
b) The supplier should be able to demonstrate good credit control procedures with debts being collected in a timely manner.
c) A good sales ledger system should be in place preferably computerised and kept up-to-date.
d) The business should be able to demonstrate that it is trading profitably and has a tangible net worth. Audited accounts may be required as evidence of the financial strength of the business.

The major features of an invoice discounting facility are outlined below:
a) The supplier is responsible for the continued maintenance of the sales ledger and the collection of sums due for payment.
b) The supplier’s customers are unaware of the invoice discounting facility.
c) The service provider will open a trust account at a nominated bank in the name of the supplier. All remittances collected by the supplier must be paid into this account.
d) The supplier will send regular notifications of invoices to the service provider together with supporting documentation as agreed with the service provider.
e) Credit Notes should be advised in the same manner.
f) The service provider will make available to the supplier an initial payment against invoices at an agreed percentage which can be up to 85% of the value of the invoices including VAT.
g) The remaining percentage will be paid to the supplier when the customer has made its payment which should be cleared through the nominated trust account.
h) The service provider will send the supplier monthly statements which will include a sales ledger control account.
i) The supplier will be required to provide a detailed sales ledger analysis at each month-end which must include a reconciliation to the service provider’s sales ledger control account. An age analysis will be required by the service provider.
j) The service provider will normally unapprove any debts older than 90 or 120 days from invoice dependent on the terms of the invoice discounting agreement between the supplier and the service provider.
k) The service provider will require to undertake regular audits of the suppliers accounting records primarily the sales ledger normally on a quarterly basis.

Please note definition of terminology used in this article as follows:
The Supplier – refers to the business providing goods or services business to business on credit terms.
The Customer – refers to recipient of the goods or services provided by the Supplier.
The Service Provider – refers to the financial organisation offering an Invoice Discounting facility to the Supplier.