Need access to business funding but can't get a loan? Compare your debtor financing options.
If your business has cash flow issues and you don't have the assets or the ability to get bank funding, you may want to consider debtor finance.
There are two main forms of debtor financing: invoice factoring and invoice discounting. In general, invoice factoring may suit small or growing businesses, while invoice discounting may be suitable for large, established businesses.
Find out how debtor finance works, the key differences between factoring and discounting, and which one may be right for your business in our guide below.
What is debtor finance?
Debtor financing is a way to fund your business by using outstanding invoices to get finance. Instead of waiting for invoices to be paid, a finance provider will give you immediate access to a percentage of the invoice as a line of credit in return for a fee. This can be an effective way for both small and large businesses to get working capital and to remove the cash flow issues that can be caused by slow-paying invoices.
Unlike traditional business loans, debtor finance gives you access to capital without having to use an asset as collateral against the loan or having to meet strict lending requirements.
What is invoice factoring?
Invoice factoring, or debt factoring, is a comprehensive form of debtor finance that gives you access to a line of credit against your unpaid invoices. The finance provider also manages the collection and accounting services on behalf of your business. Each invoice is tracked and ledgered individually, and is settled when the specific payment for that invoice is made.
Your business will generally receive 80% of the invoice amount upfront, with the remaining 20% released when the invoice is paid. You send the invoice to the finance provider, who then manages the collection of payments, making it suitable for small or growing businesses that may not have the time to chase up outstanding invoices.
What is invoice discounting?
Invoice discounting also gives you access to a revolving line of credit based on your unpaid invoices. If your business offers extended credit terms to customers (generally 30-to-60 days), invoice discounting allows you to "sell" your invoices upfront at a discounted rate. Your business will generally receive 80%-85% of the invoice amount upfront, minus fees, with the remaining percentage available once the invoice is paid.
Your line of credit will therefore change as invoices are paid or other invoices are issued. Unlike invoice factoring, your business continues to handle the accounting and collection of invoices, meaning invoice discounting is generally better suited to large companies with their own credit and accounting departments. Invoices are generally issued in batches, and your business must reconcile invoice payments directly.
What does debtor finance cost?
Under both invoice discounting and invoice factoring, you will generally be charged a fee equal to a percentage of the invoice amount. Invoice discounting fees will likely be smaller, as the collection and management of the invoices is still handled by the business itself.
As debtor finance is a form of business line of credit, you may also be charged interest on the finance you use.
What are the key differences between invoice factoring and invoice discounting?
Keep in mind the following differences when deciding between invoice factoring and invoice discounting:
- Flexibility. Invoice discounting may require you to finance most or all invoices at the maximum funding rate possible, which is usually 80%, and invoices are issued in bulk. Invoice factoring lets you choose which particular invoices and even which customers you want to finance.
- On-demand vs ongoing funding. As invoice discounting may require you to finance your entire sales ledger, you should think of it as a line of credit linked to your account receivables. This means you have access to an ongoing source of funding. Invoice factoring allows you to select which invoices to finance and when, giving you on-demand funding.
- Debt collection/management services. Invoice discounting does not offer debt collection services, making it suitable for businesses that have their own internal collection and accounting services. In contrast, invoice factoring almost always offers debt management services.
- Cost. As invoice discounting does not include collection services, it is generally cheaper than invoice factoring. However, for a small business without an accounting department, invoice factoring may still make financial sense over creating an internal department to manage invoice collection or outsourcing it to another party.
- Confidentiality. Invoice discounting may offer confidentiality as far as your customers knowing, or not knowing, whether you're using a financing company to collect invoice payments. However, invoice factoring usually means your customers are notified that their invoices are going to be managed and collected by a third party.
- Invoice verification. Generally, invoices are not verified by the finance provider under invoice discounting since the collection and management of the invoice is handled by the business itself. Alternatively, invoices will generally need to be verified under invoice factoring since the provider is responsible for securing payment.
Which one is right for my business?
Because of the flexibility and credit management services, invoice factoring is popular with small businesses. At the same time, invoice discounting is usually better suited to large companies that have in-house collection services.
- What do I need the funds for? If you need an ongoing source of financing because, for instance, your business is growing quickly, invoice discounting may be the right option for you, provided you can manage the collection of payments. But if you're strapped for cash on occasion, such as when trying to make payroll or when dealing with seasonal down periods, invoice factoring may be better suited to you since you're able to choose how many invoices to finance and when.
- Do I need credit/debt management and collection services? Small businesses may want to take advantage of the credit management services that invoice factoring companies offer while large businesses may not need such a facility.
- How much can I afford to pay? One drawback of invoice factoring is cost. Since you're financing single invoices (or single batches of invoices), set-up and maintenance costs are increased. Moreover, the credit management services that come with invoice factoring are an added expense embedded into the discount rate (fee). Make sure you're well aware of all costs associated with invoice factoring or any type of facility before you select that financing option.
Is my business eligible for debtor finance?
While debtor finance does not have the same strict lending requirements of most business loans, your business will still likely need to meet certain criteria to be eligible for debtor financing. You will need to demonstrate the following:
- Your business is well managed
- Your clients have good commercial credit
- Your invoices are not owned elsewhere or already used as collateral
You will generally also need to provide the following information to be eligible for debtor finance:
- Your financial statements
- Your collection and credit processes
The process for setting up invoice factoring is generally quicker and more flexible than for invoice discounting, as the finance provider handles the collection of the unpaid invoices.