Factoring means a finance company advances cash against your invoices and takes over collecting payment from your customers, while invoice discounting gives you the same cash advance but you keep control of credit control and your customers typically do not know you are using finance.
People confuse these two constantly, and for good reason. Both are invoice finance. Both release cash tied up in unpaid invoices. Both charge a service fee plus interest on drawn funds. But they handle your customer relationships very differently, and that distinction matters more than most comparisons let on.
How Factoring Works
With factoring, you hand over your sales ledger management to the finance provider:
- You deliver goods or services and raise an invoice
- You send the invoice details to your factoring company
- The factor advances 80% to 90% of the invoice value, typically within 24 hours
- The factor contacts your customer directly to collect payment
- Your customer pays the factor, not you
- The factor releases the remaining balance minus their fees
The critical point: your customer knows. Invoices carry the factor’s payment details, and their credit control team chases payment.
Most factoring includes credit management – the factor runs credit checks on your customers, sets limits, and manages collections. For businesses without a dedicated accounts receivable person, this is genuinely valuable.
How Invoice Discounting Works
Invoice discounting gives you the same cash advance but you keep control:
- You raise an invoice as normal
- You send the invoice details to your discounting provider
- The provider advances 80% to 90% of the invoice value
- You collect payment yourself, using your own credit control
- Your customer pays into a trust account (or directly to you)
- The provider takes their fees and releases the balance
The critical point: your customer usually does not know. Invoices go out with your normal payment details. Your team chases payment as always. This is where the term “confidential invoice discounting” comes from – it is designed to be invisible to your customers.
Key Differences at a Glance
| Dimension | Factoring | Invoice Discounting |
|---|---|---|
| Who collects payment | The factor | You |
| Customer awareness | Customers know | Usually confidential |
| Credit management | Included | You manage it |
| Cost | Higher (1.5% to 3% service charge) | Lower (0.5% to 1.5% service charge) |
| Minimum turnover | Often from £50,000+ | Usually £500,000+ |
| Contract flexibility | Spot or whole-ledger options | Usually whole-ledger |
| Admin burden | Lower | Higher |
| Control over collections | Less | Full |
When Factoring Is the Better Choice
- You do not have a credit control function. If chasing invoices falls to someone who should be doing something else, factoring outsources that entirely.
- You want to save time on collections. Handing off collections is a practical decision, not a weakness.
- You are a smaller business. Factoring is available at lower turnover thresholds. Under £500,000, it may be your only invoice finance option.
- Your customers already deal with third parties. In construction, recruitment, and transport, factoring is so common that customers expect it. No stigma attached.
When Invoice Discounting Is the Better Choice
- Customer perception matters. Some customers interpret a third-party collection notice as a sign of financial difficulty. Confidential discounting avoids that entirely.
- You have strong credit control already. If your team chases payments well and your DSO is healthy, there is no reason to pay someone else. Use the DSO Calculator to check where you stand.
- You are a larger business. Discounting is generally aimed at turnover above £500,000 to £1 million. Providers expect you to have the processes to manage your own ledger.
- You want to maintain direct relationships. In professional services and creative industries, a third party chasing your invoices can feel jarring. Discounting keeps the relationship in your hands.
The Confidential vs Disclosed Distinction
This cuts across both products and is worth understanding clearly.
Confidential means your customers do not know. Invoices look normal. Payment goes to your account (or a trust account that looks like yours). Confidential invoice discounting is the most common arrangement for larger businesses.
Disclosed means your customers are aware. This is standard with factoring – invoices carry the factor’s details.
These are not rigid categories, though. Some providers offer disclosed invoice discounting or confidential factoring (collections managed under your brand name). The market has more flexibility than the textbooks suggest.
What Does Each Cost?
Factoring costs
- Service charge: 1.5% to 3% of invoice value (includes credit management)
- Discount charge: Base rate plus 1.5% to 3% on funds drawn
- Credit protection (optional): 0.5% to 1% for non-recourse (bad debt protection)
On £600,000 annual turnover with £60,000 average drawn funds, factoring might cost:
– Service charge (2%): £12,000
– Discount charge (8% on £60,000): £4,800
– Total: approximately £16,800 per year
Invoice discounting costs
- Service charge: 0.2% to 1.5% of invoice value (lower – no credit management included)
- Discount charge: Base rate plus 1.5% to 3% on funds drawn
On the same numbers, invoice discounting might cost:
– Service charge (0.75%): £4,500
– Discount charge (8% on £60,000): £4,800
– Total: approximately £9,300 per year
The £7,500 difference is essentially the price of outsourcing credit control. Whether that is good value depends on what it would cost you to do it yourself.
Worked Example: The Same Business, Two Different Approaches
Tom runs a recruitment agency in Bristol with £1.5 million turnover and typically £250,000 in outstanding invoices. He places temporary staff with a mix of large corporates and smaller local businesses.
If Tom chooses factoring
The factor advances 85% of each invoice – up to £212,500 available. The factor’s credit control team chases payment. His corporate clients do not bat an eyelid – they are used to paying factoring companies in recruitment. But two smaller local clients ask awkward questions about whether his business is struggling.
Annual cost: Approximately £35,000 (service charge of 1.75% on £1.5m plus discount charges).
Time saved: Tom no longer spends Friday afternoons chasing invoices. His bookkeeper can focus on other tasks.
If Tom chooses invoice discounting
Same cash advance – 85% of invoices, up to £212,500. But his team handles all collections. Customers pay into his trust account. Nobody knows he is using finance.
Annual cost: Approximately £20,000 (service charge of 0.5% on £1.5m plus discount charges).
Time required: His bookkeeper continues spending a day a week on credit control.
The £15,000 difference buys credit control services and saves roughly 60 days of staff time per year. Whether that is worth it depends on what Tom values more – the cost saving or the time saving.
Things to Watch Out For
Lock-in periods. Some contracts require 12 to 24 months’ commitment with 3+ months’ notice. Check exit terms before you sign.
Concentration limits. If one customer is more than 25% to 40% of your ledger, providers may limit advances against those invoices.
Recourse vs non-recourse. With recourse facilities (the most common type), if your customer does not pay, you owe the money back. Non-recourse includes bad debt protection but costs more. Make sure you understand which you are being offered.
Minimum volumes. Some providers charge minimum fees regardless of how many invoices you put through. If your turnover is seasonal, check you will not be paying for unused capacity.
For a broader view of working capital options, see Working Capital Finance Options. If you are weighing invoice finance against a simpler overdraft, Invoice Finance vs Bank Overdraft covers that comparison.
Which Is Right for You?
The decision comes down to three questions:
- Do you have the capacity to manage your own credit control? If not, factoring does it for you. If you do, discounting lets you keep control and costs less.
- Would your customers care? If they are in industries where factoring is common, it will not matter. If they would see it as a red flag, confidential discounting is the safer choice.
- What is your turnover? Below £500,000, factoring is usually your main option. Above that, both are available and the choice is genuinely yours.
Neither product is inherently better. They serve different operational needs, and the right answer is the one that matches how your business actually works. To understand how reducing your collection times could change the equation entirely, read How to Reduce Your DSO.
This article is for informational purposes only and does not constitute financial advice. Invoice finance terms, costs, and availability vary by provider and business circumstances. If you are considering invoice finance, speak with a qualified financial adviser or broker who can assess your specific situation.