What is the Difference Between Invoice Financing and Invoice Discounting? Which Option Should You Choose?

Although invoice financing has always been an effective financing avenue for businesses, recent events such as the pandemic, rising freight prices, and steep inflation have further pushed organizations towards opting for it over other cheaper finance-raising alternatives. 

The Indian invoice financing market stood at a staggering ₹8 lakh crore in 2021. There are multiple reasons for this gargantuan market size; with one of them being that invoice financing enables businesses to overcome working capital issues caused due to sluggish cash-to-cash (C2C) conversion cycles. As per a 2018 study conducted by E&Y, Indian companies had more than ₹1.8 trillion trapped in their respective balance sheets and their C2C conversion cycles – either in inventory or tied up with debtors. 

Invoice financing is a wide term with multiple classifications. The two most commonly-used invoice financing methods are invoice discounting and invoice factoring. Several economists use the terms invoice discounting and invoice financing interchangeably. While that is not incorrect, there are certain elements that clearly differentiate the terms. 

So, what is the key difference between invoice financing and invoice discounting? Also, is one option necessarily better than the other?

The case for and against invoice financing

Invoice financing is a type of short-term borrowing that a lender provides to the lendee (the main beneficiary of invoice financing) against their unpaid invoices and accounts receivables. So, a business can provide these documents to a specialized invoice financing company or a financial institute in exchange for an immediate injection of liquid cash into their business operations. This cash amount can be up to 90% of the amount specified on the invoices. 

As is the case with invoice discounting, businesses use this option to either boost their cash flows or plug gaps in their working capital to keep their operations running relentlessly.

Pros of invoice financing

• As stated above, invoice financing lets businesses maintain steady cash flows and removes the need for them to wait for their debtors to pay them after they have sold their goods or services to them.
• The borrowing limits in invoice financing are highly dynamic in nature as they are not set solely on the basis of the creditworthiness of a business. Instead, the performance and growth-based aspects of a business are equally instrumental for a given business to gain access to finances in exchange for its invoices.

Cons of invoice financing

• Invoice financing is an expensive financing alternative for businesses compared to other options. 
• Certain invoice financing sub-categories, such as invoice factoring, involve businesses directly contacting their customers to recover the payments against the invoices. This may affect the relationship between businesses and their customers as the latter may not be comfortable with the presence of a third-party entity in an existing sale and purchase partnership. 

The case for and against invoice discounting

In invoice discounting, businesses get a quick loan in exchange for their commercial invoices. The discounting company keeps the invoices as collateral to secure the loan. Unlike factoring companies, discounting companies do not get in touch with the end customers to recover the pending payment amounts specified on sales invoices. Instead, the onus of recovering the invoice money from the end customers is exclusively on the lendee.

Pros of invoice discounting

• As invoice discounting companies do not interfere with the task of monetary recovery from the customers of a business, the relationship between a business and its customer is not affected. 
• Unlike regular business and commercial loans, invoice discounting has negligible turnaround time. This is enormously helpful for businesses who are contractually obligated to make payments to their service providers while their own money is stuck at the invoice stage.

Cons of invoice discounting 

• By design, the loan amount provided in invoice discounting only covers the partial or full amounts of the current accounts receivables. As a result, this is not an ideal alternative for businesses to raise large amounts of money or specific sums.
• Generally, this financing avenue involves money being lent to businesses on commercial invoices only. This attribute can result in businesses dealing directly with the general public to look for other financing options.       

The difference between invoice financing and invoice discounting

Although invoice discounting is a category of invoice financing, there are certain areas in which subtle differences appear, including in:

• The price point of invoice financing, in general, is around 1% per month. On the other hand, discounting charges can be higher, with components such as management fees, establishment fees, and interest amounts subtracted from the financing money.
• Confidentiality in services is a highlight of invoice discounting. On the other hand, invoice financing contains an equal number of options in which the customer of a business knows about the involvement of a third-party element.
• The onus of invoice amount recovery in invoice discounting rests on the business (beneficiary of invoice discounting). On the other hand, invoice financing contains alternatives, such as factoring, in which the factoring company manages the recovery-related tasks.
• Money is offered in the form of a loan in invoice discounting. Businesses availing invoicing need to repay this amount just like a bank loan with specific interest amounts and fees added on. Invoice financing, or its factoring option to be precise, has factoring companies paying money to businesses against their pending accounts receivables and invoices and later recovering that amount from their customers.

Invoice discounting is a subset of invoice financing, which itself has other sub-categories. Hence, highlighting the true difference between invoice financing and invoice discounting remains a challenge. Businesses need to evaluate the pros and cons of each alternative before choosing one for their financing. 

If businesses are looking for diverse solutions for their financing requirements, then Bizongo can be a good option for them. Bizongo’s digitized and data-driven supply chain financing and vendor management systems enable businesses to maintain their business continuity seamlessly. Kindly contact us to discover our supply chain solutions that can both streamline and revolutionize your business.