When a business sells on credit, cash is locked in unpaid invoices until customers pay — typically 30 to 90 days later. Both invoice factoring and invoice discounting solve this problem by advancing cash against outstanding invoices before they are due. The critical difference is who collects the debt.
For a detailed look at how factoring works on its own, see the guide to invoice factoring.
How Invoice Factoring Works
With invoice factoring, you sell your unpaid invoices to a factoring company (the factor). The factor advances a percentage of the invoice value immediately and takes over the responsibility for collecting payment from your customers.
The Factoring Process
- You deliver goods or services and issue an invoice to your customer
- You send a copy of the invoice to the factoring company
- The factor advances 70% to 90% of the invoice value, usually within 24 hours
- The factor chases and collects payment from your customer
- Once the customer pays, the factor releases the remaining balance minus their fee
Your customer knows that a factoring company is involved because the factor contacts them directly to collect payment.
How Invoice Discounting Works
With invoice discounting, you also receive an advance against your unpaid invoices, but you retain control of your sales ledger and continue collecting payments yourself. The arrangement is typically confidential — your customers do not know that a finance provider is involved.
The Discounting Process
- You deliver goods or services and issue an invoice to your customer
- You notify the discounting provider and receive an advance of 70% to 90% of the invoice value
- You continue to chase and collect payment from your customer as normal
- When the customer pays into a designated trust account, the discounting provider takes back their advance plus fees
- The remaining balance is released to you
Key Differences
| Feature | Invoice Factoring | Invoice Discounting |
|---|---|---|
| Who collects payment | The factor | Your business |
| Customer awareness | Customers know (disclosed) | Usually confidential |
| Sales ledger management | Handled by the factor | Handled by your business |
| Credit control | Factor manages chasing and collections | You manage chasing and collections |
| Bad debt protection | Available (non-recourse factoring) | Rarely included |
| Typical advance rate | 70-90% | 75-90% |
| Typical cost | 1-5% of invoice value + service charge | 0.5-3% of invoice value |
| Minimum turnover | Often from £50,000 | Usually £100,000+ |
| Contract length | 12-24 months typical | 12-24 months typical |
| Best for | Smaller businesses, those needing credit control help | Established businesses with strong internal processes |
Costs in Detail
Both services charge fees in two parts:
Factoring Fees
| Fee component | Typical range | Covers |
|---|---|---|
| Service charge (administration fee) | 0.5% - 3% of turnover | Sales ledger management, credit control, collections |
| Discount charge (finance charge) | 1.5% - 4.5% over base rate | Interest on the money advanced |
Invoice Discounting Fees
| Fee component | Typical range | Covers |
|---|---|---|
| Service charge | 0.2% - 0.5% of turnover | Administration and monitoring |
| Discount charge | 1.5% - 3.5% over base rate | Interest on the money advanced |
Invoice discounting is generally cheaper because the provider does less work — they are not managing your sales ledger or chasing your customers.
Recourse vs Non-Recourse
Recourse
With a recourse arrangement, if your customer does not pay, the debt comes back to you. You must repay the advance to the factor or discounter. This is the standard arrangement for most UK providers.
Non-Recourse
With non-recourse factoring, the factor absorbs the loss if a customer fails to pay due to insolvency. This is effectively a form of credit insurance built into the service. Non-recourse is more expensive but protects you against bad debt.
Non-recourse arrangements typically only cover insolvency — if a customer simply refuses to pay due to a dispute, the debt usually reverts to you.
Which Should You Choose?
Choose Factoring If
- You are a smaller business without a dedicated credit control team
- Your customers already expect to deal with third parties for payment
- You want the factor to handle the entire collections process
- You want access to bad debt protection (non-recourse option)
- You are comfortable with customers knowing about the arrangement
- Your accounts receivable management is taking up too much time
Choose Invoice Discounting If
- You are an established business with a proven track record of collecting debts
- Confidentiality matters — you do not want customers to know about the financing
- You have strong internal credit control processes
- Your annual turnover exceeds £100,000 (many providers require this as a minimum)
- You want the lower cost of retaining control over collections
- Customer relationships are important and you want to manage them directly
Selective vs Whole Turnover
Both factoring and discounting are available on a whole turnover basis (all invoices are included) or a selective basis (you choose which invoices to finance).
| Approach | Advantage | Disadvantage |
|---|---|---|
| Whole turnover | Simpler administration, usually lower percentage fee | Must include all invoices, even reliable payers |
| Selective | Only finance when needed, more flexibility | Higher per-invoice cost, more complex administration |
Selective invoice finance (sometimes called spot factoring) is useful for businesses with seasonal cash flow or those that only need to accelerate payment on specific large invoices.
Accounting Treatment
Recording the Advance
When the factor or discounter advances funds against an invoice:
Debit: Bank
Credit: Factoring / discounting liability
When the Customer Pays
For factoring (factor collects):
Debit: Factoring liability
Credit: Trade receivables
For discounting (you collect into a trust account):
Debit: Factoring liability
Credit: Trade receivables
Recording Fees
Debit: Finance costs (P&L)
Credit: Bank / Factoring liability
The outstanding advance appears as a current liability on the balance sheet until the customer pays and the arrangement settles.
Impact on Customer Relationships
One of the most significant practical considerations is how each option affects your relationship with customers.
With factoring, your customers deal with the factor for payment queries, reminders, and debt recovery. This can feel impersonal, and some customers may interpret the involvement of a factoring company as a sign that your business has cash flow problems.
With invoice discounting, your customers see no change. You continue to send invoices, reminders, and statements as before. This preserves the relationship and your professional image.
Alternatives to Consider
If neither factoring nor discounting is right for your business, other options include:
- Overdraft facility — Flexible borrowing against your bank account
- Business loan — A fixed amount borrowed for a specific period
- Asset finance — Borrowing secured against equipment or vehicles
- Revenue-based financing — Repayments linked to your turnover