Invoice Finance – Factoring or Discounting?
Like many industries, the invoice finance industry is full of jargon which can make it difficult to understand if it’s not something you are used to. To help you negotiate your way through the language of invoice finance then, we offer below the following key information on each of the main invoice finance products out there. And, in addition, provide you with explanations on much of the jargon used in the industry to assist you in your choice of service.
Back to basics
The two principal products we will discuss here are Invoice Factoring and Invoice Discounting.
Let’s start with the basic difference:
Factoring facilities are a complete outsourcing of the sales ledger, with invoices being collected by the factoring company in their name. The factor will buy the invoice from you and this will be disclosed to your customer by a notice on the invoice.
Invoice Discounting facilities are in most cases confidential, in that your customer is not aware that you are receiving a funding line secured against your invoice to them. You retain control of the credit control function.
Both products will provide an advance against your invoice value at an agreed percentage rate (typically 75 to 85%) at the time you pass the invoice to the invoice finance provider. The balance will be paid at the time of payment by your customer. The providers will charge two basic fees, a service charge for providing the service, and a Discount fee, which is the interest on the money you are borrowing. The discount fee can be over Bank rate or LIBOR. These fees are taken on an on-going basis from your account.
Accounts receivable - These are your debtor sales invoices also known as your sales ledger.
Application for payment - These are common within the construction sector, rather than raising an invoice an application for payment is produced. This can be uncertified and then become certified once it is approved to be paid. Funding can be provided against applications for payment, both certified and uncertified, in the same way as against invoices.
Approved debt - A debt which has been accepted by the financier as eligible for prepayment.
Asset based lending - Asset based lending refers to a financial service whereby the provider will fund against a range of assets within their customer's business e.g. sales invoices, property, plant and machinery, and stock.
Asset finance - Asset finance refers to a set of financial product that leverage the assets of a business to raise finance. These products include factoring, invoice discounting, leasing, hire purchase and stock finance.
Assignment, assign, assigning - The legal process by which a factoring of invoice discounting company takes ownership of rights to receive payment in respect of their client's sales invoices. This enables the factoring company to provide prepayments against the invoices.
Auction platform - There are web sites that allow you to auction single or batches of invoices to investors that will bid for them. The investors will normally bid the fee that they are willing to accept and the prepayment that they are prepared to give.
Availability - The amount of cash available to the client of a funder, also called "available funds".
Broker - A third party that introduces a customer to a provider.
Cash invoice or payment terms - A sales invoice that is required to be paid immediately i.e. without a credit period.
CIS - Construction Industry Scheme where contractors deduct tax from sub-contractors payments and pass it to HMRC.
Client - A common terms used instead of customer for customers of financiers.
Confidential invoice discounting - A facility where the debtors are not aware of the invoice discounter's involvement.
Confidential Factoring - A facility where you receive funding and credit control support without your debtors being aware of the providers involvement.
Credit control - The process of ensuring that a business only gives credit to customers that are able to pay, and ensuring that outstanding sales invoices are paid on time. The process includes collecting sales invoices, often through a combination of sending letters, statements (or emails) and calling debtors by telephone. Also known as Dunning or Collections.
Credit note - A credit that can be taken against an invoice, often given to correct errors, give a discount or resolve a dispute. Credit note levels are key to invoice finance companies as they dilute the value of the debts against which they fund.
Credit period - The amount of time granted to the buyer by the seller before which the buyer must pay the sellers invoice e.g. 30 days net, 60 days net.
Credit protection - Protection against debtors not paying due to insolvency or in some cases protracted default. Also known as non recourse.
Current account - The amount of the financial obligation of a client to a financier. Normally the total of all prepayments, plus fees and charges, less all payments received from the client's customers (debtors).
Debit note - A debit note, sometimes called a debit memorandum, or debit memo, is a document issued by a buyer to a seller as a means of requesting a credit note. A seller may also issue a debit note, as an alternative to raising another invoice, to upwardly adjust the value of an invoice that has already been issued.
Debt - An amount owed by a debtor to a creditor. Invoices are often evidence of such a debt.
Debt Factoring - Another term for factoring that refers to the fact that you are factoring the debts that your customers (debtors) owe you.
Debtors - Parties that owe you money i.e. have sales invoices outstanding to them on credit terms, also called customers.
Disapproved - An invoice which is not funded for reasons such as being over the recourse period or being disputed. Also called "unapproved debt" by some factors.
Disclosed invoice discounting - An invoice discounting facility whereby the client receives early payments against their sales invoices but retains responsibility for telephone and paper based collection of payments from debtors. Payments are banked by the client into a "Trust Account" which is controlled by the discounter.
Discount charge - Part of the cost of factoring or invoice discounting. A percentage over base rate or LIBOR charged in respect of the level of the outstanding liability of the client to the factor or discounter.
Dunning letters - Chasing letters sent to debtors to encourage payment of outstanding sales invoices.
Early payment - Also called "Prepayment". The funds provided to the client against their invoices. Normally expressed as a percentage e.g. 85% of the gross value.
Export finance or export factoring - A factoring facility in respect of debtors based abroad. This may include a collections (credit control) service, funding against invoices and bad debt protection (non recourse).
Factoring - A facility whereby the client receives early payments against their sales invoices and a collections service to chase in unpaid debts. Bad debt protection (non recourse) may also be provided.
Factoring fee - See service charge.
Funding limit - This can have two different meanings. In some cases it refers to the maximum limit that the Current Account can reach. In other situations it means a limit set on a debtor with the purpose of restricting funding against invoices to that debtor beyond the value of the funding limit.
High involvement - The total a debtors account constitutes as a percentage of the total sales ledger.
Import factoring - Import factoring is a service offered to clients abroad who have customers within this country. The import factor will undertake the collection of sales invoices locally providing a service to the exporter abroad.
Independent factoring company - A factoring company that is not owned by one of the high street banks.
Invoice - An invoice is a document detailing the payment required (or in the case of cash or pro-forma invoices already made) in respect of good or services provided.
Invoice discounting - Invoice discounting is a facility whereby the client receives early payments against their sales invoices but retains responsibility for telephone and paper based collection of payments from debtors.
Invoice finance - Also known as invoice financing, sales finance or receivables financing, is an umbrella term for the provision of a factoring (with credit control) or invoice discounting (funding only) service.
Invoice finance company - The company or organisation that provides the factoring, invoice discounting or invoice finance facility. Also known as invoice financiers, invoice finance houses, factoring companies, invoice discounters or receivables finance houses.
JCT - (Joint Contracts Tribunal) are standard contracts used in the construction sector, against which funding can be provided.
Letter of credit - Letters of credit are financial instruments, issued by a bank, that undertake to pay a fixed sum to a seller on production of specified documentation. They can be arranged as part of a Trade Finance facility.
Non Recourse - Non recourse refers to an invoice finance facility that includes up to 100% protection against bad debts. If your debtor becomes insolvent the invoice finance company will credit the value of the invoice to your account (the remaining balance if a prepayment has already been provided to you).
Notifiable Invoice - The term "notifiable invoice" means an invoice that has to be notified (or sent) to the invoice finance company, The opposite of a non-notifiable or excluded invoice which does not need to be sent.
Overdraft - A form of bank lending where a customer is authorised to overdraw their current account by an agreed amount. The amount is fixed, unlike an invoice funding or finance arrangement, where the amount of funding grows in line with the growth of the business.
Overpayments (overpayment facility) - An overpayment is an additional amount of funding made available by a factor or invoice discounter in excess of the normal early payment percentage that they provide.
Phoenix - A business that "rises from the ashes" of a previous business that failed. Invoice finance can help with such situations.
Prepayment, Early Payment or Initial Payment - Also called "Early Payment" or "Initial Payment". The funds provided to the client against their invoices. Normally expressed as a percentage e.g. 85% of the gross value.
Proforma invoice - A sales invoice raised in respect of the supply of goods or services that is required to be paid on cash terms.
Purchase ledger - The accounting structure that holds details of all the purchase invoices.
Purchase order finance - An advance of money to your supplier to pay for goods. See Trade Finance.
Recourse - An invoice finance facility where you have chosen not to take advantage of protection against bad debts. With a recourse factoring or invoice discounting facility, if the debtor fails to pay the factoring company or invoice discounting company will withdraw any prepayment that has been provided against the invoice.
Retention of title - Retention of title or ROT is a clause in a set of terms or a contract setting out that the title of the goods supplied does not pass to the buyer, until the buyer has paid the supplier.
Reverse factoring - See Supply Chain Finance below.
RPO - Recruitment Process Outsorcing (RPOs) organisations are large recruitment purchasing organisations that provide staff to businesses. Many smaller recruitment companies provide staff through these umbrella organisations to end users. Many invoice financing companies have difficulty funding RPOs but we have partners that can help you fund them.
Sales finance or sales financing - Another term for invoice finance (see above).
Sales invoice - An invoice raised by a seller in respect of the sale of goods or services.
Sales ledger - The accounting structure that holds details of all the sales invoices.
Selective invoice finance, factoring or invoice discounting - Similar to spot factoring (see below) whereby the client can select particular invoices or debtors to factor or discount without the obligation to factor or discount all of their sales turnover.
Self billing - Some large organisations self bill rather than letting their customers raise sales invoices. These can still be funded through sales finance.
Stage payments, staged payments or interim payments - Several invoices raised in respect of each stage of a project e.g. 50% after stage 1 is complete and 50% after stage 2.
Selective invoice finance - A form or factoring or invoice discounting where the client is able to select either specific debtors or specific invoices to be funded and or collected under the invoice finance facility. See also Spot factoring below.
Service charge - Service charge is one aspect of the fees levied by a factor or discounter in respect of the service provided. Normally expressed as a percentage of the clients sales turnover although in some cases it can be a fixed fee.
Spot factoring - Factoring of single invoices on a selective basis.
Statement of account - A summary of all the transactions on a debtors account e.g. invoices, credit notes and payments.
Supply chain finance - Supply Chain Finance or Reverse Factoring is an umbrella arrangement where invoice finance is provided to a number of suppliers in a single customers supply chain based on the strength of the customer.
Trade finance - Trade Finance refers to a set of financial products that can assist fund the import and export of goods. This can include setting up letters of credit and dealing with documentation and bills of exchange.
Trust account - Where a client is using an invoice discounting product a bank account is set up by the provider (discounter) into which the client banks all payments received from debtors.
Vendor - Another name for a supplier or seller.