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Factoring vs Invoice Discounting: What’s the Difference?

Starting a trucking business can be costly, and you’ll need a strong cash flow to remain competitive. After all, the goal is to expand, which is difficult without enough cash on hand. 

Drivers need to be hired, the fuel must be paid for, and special equipment must be purchased to improve efficiency. Paying for these items upfront can put you in debt, but invoice financing can help secure the cash you need and avoid high percentage rates charged by credit card companies. So let’s take a look at the two types of financing available, invoice discounting and factoring

What Is Factoring?

Finding a freight factoring company is considered a necessity by many trucking companies for several reasons. But what exactly is factoring, and why would it benefit your business? 

Factoring allows you to sell unpaid invoices to a company that pays you between 80% and 90% of the amount billed. The factoring company then assumes the responsibility of collecting the payment from the customer. 

For example, suppose you deliver a load to one of your clients. After the delivery, you’d send the invoice to the factoring company, which then pays you an agreed-upon percentage of the full amount within 24 hours. You won’t have to wait 30 days or more to receive the cash from that delivered shipment. 

The factoring company follows up with the client and collects the full invoiced amount. After doing so, they’ll forward you the money minus the contracted fee. Fees vary depending on the company but typically remain in the 1% to 5% range.

Factoring is an excellent way to keep your company’s cash flow healthy without needing a bank loan. One of the great aspects of factoring is that it doesn’t involve a business credit check

Applying for a bank loan is a lengthy process that requires you to submit a ton of paperwork as they dive into your company’s financial history. With freight factoring, the credit history of your customers is reviewed instead.

The factoring company wants to know how long it takes your clients to repay their debts. Doing so will help you identify bad payers and improve your ability to collect payments. 

What Is Invoice Discounting?

So, how does invoice discounting work? Invoice discounting is when you’re loaned a percentage of the dollar amount listed on your accounts receivable ledger. 

Once you collect invoices from your customers, you’ll let the invoice discounting company know, and they’ll lend you an amount based on the full value of the invoices. The discounting company will take a small percentage.

For example, let’s say you invoice a customer for $10,000 for a shipment you’ve completed. Next, you upload the invoice to the online account you have with the lending company. The agreement is for 75% of the invoiced amount, so you’ll receive a $7,500 advance. 

After a few weeks, the customer makes their payment to an account controlled by the lender. However, the customer believes they are making the payment directly to you. The invoice discounting company pays you the remaining $2,500 minus their fee, which is usually between 1% and 3%. 

Comparing Factoring & Invoice Discounting

You may be thinking the two are pretty similar, so what is the difference between factoring and invoice discounting? Let’s look at some of the differences to help you make an informed decision. 

Loans

Invoice discounting is basically a small business loan that must always be repaid. It is a riskier option than freight factoring, where the third-party company purchased the invoice outright. 

Because you’re receiving a loan, your credit history will be checked. If it is less than favorable, the rates you are charged will likely be on the higher side. However, the more your business grows, the more funding you can access. 

Some discounting companies require a minimum contract length. You may be locked into your original percentage rate for a long period, even after your credit improves.

As with many lenders, personal guarantees could be required to secure the loan. Depending on how long you’ve been in business, you may not be ready to put up an asset as collateral. 

Also, the discounting company may have an annual or monthly fee on top of the percentage rate being charged. Most companies that choose invoice discounting have been well-established for several years. 

Freight factoring allows you to collect cash for your invoice and avoid loans altogether. However, the fees taken out for factoring are often high. Also, your eligibility is dependent on your customer base. If they aren’t in the habit of paying on time, you may not qualify for this option. 

Responsibilities

Invoice discounting and factoring companies have distinctly different responsibilities. The factoring company will pursue collecting payments once they’ve bought the invoice. 

Outsourcing the task has its benefits and drawbacks. You’re able to focus on growing your business. Time spent making calls or sending emails to clients regarding their late payments can now be spent looking for new business opportunities. 

The drawback here is that you are no longer in contact with your customers. If the factoring company you’ve chosen begins to aggressively pursue your customers, it may reflect poorly on your business. 

The factoring company may offer full sales ledger services for an additional fee. You’re handing over control of your invoices to a third-party, so you want to be sure they’re trustworthy. 

You will be responsible for collecting payments from your customers if you choose invoice discounting. From the customer’s perspective, they are only doing business with you, so there is no indication you’re using a lender. 

Recourse and Non-Recourse

Invoice discounting is always a recourse loan. These types of loans leave you liable for any debt left unpaid by your customer. 

So, if they don’t pay, you will. If you don’t repay the loan, the lender is permitted to pursue any collateral or other assets you own to make up for the amount of their loss. 

Freight factoring can either be recourse or non-recourse. As with invoice discounting, you are liable for any invoices not paid if you have a recourse factoring agreement. 

You are not responsible for making a repayment to the factoring company if the client does not pay.

Rates

Factoring companies often use variable-rate structures. That way, they can connect the financing costs to the length of time the invoice has been left unpaid. The longer it takes the customer to make the payment, the higher the cost. 

You can also negotiate a flat rate with the factoring company. No matter how long the invoice has been outstanding, the rate remains the same. If you have customers who typically pay on or before time, a variable rate may be the way to go. 

However, if some of your customers are regularly late, a flat rate can save you money in the long run. It’s important to note that non-recourse agreements typically charge a higher fee as the factoring company assumes all risks when they buy your invoice. Since risk is mitigated with recourse loans, lenders typically charge lower interest rates. 

Discounting fees work similarly to the way banks charge interest. The discount charge is calculated daily and applied monthly. Since you are the one who’s in charge of collecting payments, the fee is generally lower for discounting than for factoring. There are fewer services provided, and that is reflected in the rates. 

Awareness

Your company’s reputation is on the line when choosing a factoring company to handle your outstanding invoices. Your clients are aware they are not dealing with you directly, and if the company behaves negatively, it will reflect on you. 

Some customers may be uncomfortable dealing with third parties and prefer a more personable business relationship. With invoice discounting, the client is never aware that they aren’t dealing with you when it’s time to pay their bill. Every aspect of your business seems to be handled by you, and the trust factor remains intact. 

Improve Your Cash Flow With Factoring or Discounting 

Determining which financing solution is best for your trucking company largely depends on how long you’ve been in business and your customer base. Invoice discounting and factoring each have advantages that help you access the capital needed when establishing your business. 

Emergencies are dire when you don’t have the cash to handle them quickly. That’s why it might help to consider all of the pros and cons, along with your company’s standing, before you make a final decision.

FAQ

What Is Invoice Discounting Used For?

It’s used to gain instant access to cash for your business needs.

Is Invoice Financing the Same As Factoring?

No, the two have many differences. The main one is financing is a loan against your invoices, and factoring is an outright purchase of your invoices. 

Who Uses Invoice Factoring?

Many transportation companies use factoring, along with manufacturers, distributors, government contractors, and more. 

TAFS is More than Freight Factoring

As one of the industry leaders, TAFS assists trucking companies to increase cash flow with some of the lowest factoring rates in the industry and 1-Hour Advance option.

TAFS is More than Freight Factoring

As one of the industry leaders, TAFS assists trucking companies to increase cash flow with some of the lowest factoring rates in the industry and 1-Hour Advance option.