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Invoice Discounting Vs Factoring: Which Is The Better Option For MSME Financing In India

Unlike a few decades ago, there are an endless number of options for MSME financing in India today. Up-and-coming businesses can choose between a multitude of alternatives for augmenting their working capital, maintaining business continuity, and, above everything else, keeping their balance sheets and cash flows in the green at all times. Out of all the avenues available today in MSME finance, invoice financing continues to rise rapidly. This growth is somewhat reflective of the global e-invoicing market, which is poised to zoom from US$ 8.74 billion in 2021 to US$ 29.68 billion in 2027.

That begs the question: why is invoice financing considered such a solid and reliable MSME finance option?

Several factors drive this avenue of MSME financing in India and globally. For instance, more than half of the businesses in the world expect their clients to make late payments on their invoices. Some other reasons for the popularity of invoice financing are: It enables businesses to get up to 90% of the value on their unpaid invoices immediately after making a sale, and there is no involvement of collateral in invoice financing. It is a flexible financing option in terms of credit scores for MSMEs, it offers competitive pricing to businesses, and it closes the time gap between sales being made and invoice payments being fulfilled. 

Invoice financing has multiple sub-categories, the two most prominent ones being invoice factoring and invoice discounting. These two MSME finance options share several similarities. Therefore, most businesses wonder which option is the best for them.

To determine the winner between invoice discounting vs factoring, we need to delve deeper into their working and understand the subtle differences between the two.

Invoice discounting vs factoring — the working

Factoring and invoice discounting share several similarities, even in the way they work in a real-world scenario. Here’s how they work respectively:

Factoring

In factoring, businesses sell their invoices, for which payments are pending, to a specialized factoring company. In exchange, the factoring company pays them about 80 to 90% of the invoice amount immediately. Once the debtor (or customer) of the business pays the factoring company the outstanding invoice amount, then the company will pay the remaining 10 or 20% of the invoice amount to the original seller business. A service fee will also be deducted from the amount paid to the business. In this way, factoring is a guaranteed way for businesses with a large number of outstanding invoices to recoup their money from their clients and maintain steady working capital and cash flows. As a result, this is often considered one of the more effective options of MSME financing in India.

Invoice discounting

In this MSME finance option, a discounting company lends a percentage of money listed on the accounts receivable ledger of a business. Once the outstanding invoices are raised by the business, the discounting company provides a loan that amounts to a percentage (generally 80-90%) of the total invoice amounts. 

In invoice discounting, the onus of recovering the invoice money from the business’ customers is on the business themselves. Once this recovery is made, the business that availed the discounting service can repay the loan to the invoice discounting company. In addition to this, the business will also need to pay an initially agreed-upon fee to cover the interest, cost, and risk undertaken by the discounting company (normally, about 3-5% of the total value of the invoices).

As one can see, the core working of both these MSME finance alternatives is nearly identical.

Invoice discounting vs factoring — the differences

Invoice discounting vs factoring — the differences

As implied earlier, the differentiating factors between invoice discounting and factoring offers invaluable hints to businesses that cannot decide which MSME finance option to select for their business operations. Some of the differences are:

  • Factoring companies offer several value-added services to businesses such as debt recovery and full sales ledger. On the other hand, invoice discounting does not come with such value-added services.
  • Factoring involves MSMEs offering their invoices in exchange for liquid cash to a factoring company. As a result, the factoring company takes control of and manages the sales ledger of the MSME. On the flip side, in invoice discounting, the lending company offers a loan to an MSME against their outstanding invoice amounts. In this case, the onus of recovering the outstanding invoice payments from the customer is on the MSME itself.
  • Invoice discounting is a confidential process, meaning that the customer of a given business will not know that they have taken an invoice discounting loan from an invoice discounting company.
  • Factoring offers high liquidity to businesses — up to 85 to 90% — to improve their cash flows. On the other hand, invoice discounting companies offer a comparatively smaller proportion of the amount listed in the outstanding invoices.
  • Factoring involves the temporary transfer of control of the sales ledger, debt recovery, and a few other functions from a business to a factoring company. On the other hand, invoice discounting does not involve such a transfer of responsibilities.
  • Due to the sheer number of value-added services and responsibilities involved, factoring services are more expensive compared to invoice discounting services.
  • Since the onus of debt collection is on an MSME business itself, discounting is a slightly riskier MSME finance option compared to factoring.

Both these options are useful, but how can businesses decide which one suits their requirements better? Read on to find the answer.

Invoice discounting vs factoring — the verdict

Both invoice discounting and factoring have their own set of pros and cons. Based on those, as well as other factors — such as the nature and size of a business, the urgency of monetary requirement, the preference of control in loan recovery management — a business can decide whether it needs invoice discounting or factoring to raise finances.

Speaking of factoring, its main advantages for businesses are that factoring companies enable MSMEs to focus on their core operations while they handle the sales ledger and debt recovery duties. Secondly, factoring companies are generally known to negotiate better payment terms for businesses. 

As specified earlier, there is no confidentiality involved in factoring services, with the clients of a business knowing that it will be dealing with a third-party entity during debt repayment. This may strain business relationships between the buyer and sellers. Secondly, factoring fees involve higher fees and lesser control for MSMEs.

Invoice discounting, on the other hand, are confidential as discounting companies do not interfere with recovery, customer service, and sales ledger. This provides greater control and flexibility to MSMEs.

Bigger MSMEs with their own debt recovery personnel and other specialized teams can select invoice discounting, while smaller MSMEs can find the invoice factoring option more effective for their financing requirements.

For businesses seeking to optimize their working capital with ease,  Bizongo can be the right choice. Bizongo’s tech-led supply chain financing offers capital optimization and business continuity to MSMEs and other businesses. 

Kindly contact us to delve deeper into Bizongo’s plethora of solutions for your MSME.

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