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The Differences Between Factoring and Invoice Discounting

The Differences Between Factoring and Invoice Discounting

Invoice finance funds

    Collectively known as invoice finance, factoring and invoice discounting release cash against monies already earned. Both facilities can prove to be a vital cashflow solution in this difficult economic climate.

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    Obtaining finance is becoming more of a luxury as the banks are not as credit-friendly as they were prior to the global economic recession. The situation is even made grimmer as the costs of running a business are on the rise. How do businesses survive?

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    Abiding to a professional and concise business plan, using the right accountant and having the right staff are a few key factors that can give a business momentum in the short run. However, cashflow is what makes a business. Careful management of cashflow is key to business continuity and survival.

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    It is a common mistake to confuse cashflow management with cost optimisation. Cashflow management is ensuring that your income surmounts your expenditures at any particular time in the business cycle. Cost optimisation are techniques used by businesses to realise recurring cost savings.

    Many businesses are caught flat-footed as they often have huge chunks of cash locked up in outstanding invoices. Customers could take up to 90 days to complete payment for invoices. Though this may be in the terms of the agreement, your business might be financially strained, with limited working capital to cover payroll, reduce existing debt or cover administrative overheads.

    This is where factoring and invoice discounting are here to help. Instead of waiting 30-90 days for customers to settle their bills, either facility can release up to 95% of the value of your outstanding invoices, usually within 24 hours of raising the invoices. Both facilities work in a similar way – release a pre-arranged percentage of the sales ledger almost immediately. However, they differ in the following ways:

    1. Because the funds are advanced against monies to be paid, there’s a credit control function midway through the process. A factoring arrangement allocates the credit control task, including chasing customers for payment to the finance provider. Invoice discounting allows the business to manage its clients and outstanding payments.
    2. Based on 1) above, invoice discounting is tailored to larger businesses with turnover in excess of £250k and in-house credit control systems. On the other hand, factoring is a particularly attractive option for smaller companies, including start-ups.
    3. With invoice discounting, the customers are unaware of the lender’s involvement. Moreover, factoring is typically a disclosed arrangement as the customers are notified of their invoice payment.

    Advantages of Factoring

    1. The funds released improve your cashflow position and the additional working capital created enables your business to expand.
    2. Factoring boosts your bargaining power, enabling you to capitalise on early vendor opportunities and discounts.
    3. The cash advanced grows alongside your business. This means that as your business grows, you could have access to more funding.
    4. The credit control function outsourced to the finance provider allows you to concentrate on growing your business.
    5. Unlike other forms of commercial finance such as bank overdraft, factoring could be a flexible funding facility for start-up companies.

    Advantages of Invoice Discounting

    1. The funds released improve your cashflow position and the additional working capital created enables your business to expand.
    2. Invoice discounting boosts your bargaining power, enabling you to capitalise on early vendor opportunities and discounts.
    3. The cash advanced grows alongside your business. This means that as your business grows, you could have access to more funding.
    4. The facility is typically administered on a confidential basis. You stay in contact with your customers with them unaware of the funding agreement.
    5. Because the funds are released almost immediately, there’s some certainty about cash projections.

    Other Forms of Factoring

    1. Recourse Factoring: The finance provider manages your sales ledger without any credit protection. This means that if your customers default, you are liable for all credit costs.
    2. Non-recourse Factoring: This is a factoring arrangement where the finance provider takes full responsibility of the sales ledger and bears any risks associated with bad debt. This saves your business the hassle of worrying about customer defaults.
    3. CHOC’s: Factoring is assumed to be a disclosed arrangement with outsourced credit control. However, CHOC’s (Client Handles Own Collections) facility keeps the business in charge of their sales ledger. This could be a cost-effective solution for SMEs with in-house accounting systems.

    Other Forms of Invoice Discounting

    1. Recourse Invoice discounting: The finance provider manages your sales ledger without any credit protection. If an invoice remains unpaid, the finance provider reclaims the cash previously advanced and you take on the credit control function.
    2. Non-recourse Invoice Discounting: You retain full control of your credit control system, but the finance provider offers you bad debt protection for the life of the contract.
    3. Disclosed Invoice Discounting: Your customers are notified of the lender’s involvement, making it a less risky proposition to lenders than confidential ID.
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      Last Updated on November 27, 2020

      How to Set Financial Goals and Actually Meet Them

      How to Set Financial Goals and Actually Meet Them

      Personal finances can push anyone to the point of extreme anxiety and worry. Easier said than done, planning finances is not an egg meant for everyone’s basket. That’s why most of us are often living pay check to pay check. But did anyone tell you that it is actually not a tough task to meet your financial goals?

      In this article, we will explore ways to set financial goals and actually meet them with ease.

      4 Steps to Setting Financial Goals

      Though setting financial goals might seem to be a daunting task, if one has the will and clarity of thought, it is rather easy. Try using these steps to get you started.

      1. Be Clear About the Objectives

      Any goal without a clear objective is nothing more than a pipe dream, and this couldn’t be more true for financial matters.

      It is often said that savings is nothing but deferred consumption. Therefore, if you are saving today, then you should be crystal clear about what it’s for. It could be anything, including your child’s education, retirement, marriage, that dream vacation, fancy car, etc.

      Once the objective is clear, put a monetary value to that objective and the time frame. The important point at this step of goal setting is to list all the objectives that you foresee in the future and put a value to each.

      2. Keep Goals Realistic

      It’s good to be an optimistic person but being a Pollyanna is not desirable. Similarly, while it might be a good thing to keep your financial goals a bit aggressive, going beyond what you can realistically achieve will definitely hurt your chances of making meaningful progress.

      It’s important that you keep your goals realistic, as it will help you stay the course and keep you motivated throughout the journey.

      3. Account for Inflation

      Ronald Reagan once said: “Inflation is as violent as a mugger, as frightening as an armed robber and as deadly as a hitman.” This quote sums up what inflation could do your financial goals.

      Therefore, account for inflation[1] whenever you are putting a monetary value to a financial objective that is far into the future.

      For example, if one of your financial goal is your son’s college education, which is 15 years from now, then inflation would increase the monetary burden by more than 50% if inflation is a mere 3%. Always account for this to avoid falling short of your goals.

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      4. Short Term Vs Long Term

      Just like every calorie is not the same, the approach to achieving every financial goal will not be the same. It’s important to bifurcate goals into short-term and long-term.

      As a rule of thumb, any financial goal that is due in next 3 years should be termed as a short-term goal. Any longer duration goals are to be classified as long-term goals. This bifurcation of goals into short-term vs long-term will help in choosing the right investment instrument to achieve them.

      By now, you should be ready with your list of financial goals. Now, it’s time to go all out and achieve them.

      How to Achieve Your Financial Goals

      Whenever we talk about chasing any financial goal, it is usually a two-step process:

      • Ensuring healthy savings
      • Making smart investments

      You will need to save enough and invest those savings wisely so that they grow over a period of time to help you achieve goals.

      Ensuring Healthy Savings

      Self-realization is the best form of realization, and unless you decide what your current financial position is, you aren’t heading anywhere.

      This is the focal point from where you start your journey of achieving financial goals.

      1. Track Expenses

      The first and the foremost thing to be done is to track your spending. Use any of the expense tracking mobile apps to record your expenses. Once you start doing it diligently, you will be surprised by how small expenses add up to a sizable amount.

      Also categorize those expenses into different buckets so that you know which bucket is eating most of your pay check. This record keeping will pave the way for cutting down on un-wanted expenses and pumping up your savings rate.

      If you’re not sure where to start when tracking expenses, this article may be able to help.

      2. Pay Yourself First

      Generally, savings come after all the expenses have been taken care of. This is a classic mistake when setting financial goals. We pay ourselves last!

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      Ideally, this should be planned upside down. We should be paying ourselves first and then to the world, i.e. we should be taking out the planned saving amount first and manage all the expenses from the rest.

      The best way to actually implement this is to put the savings on automatic mode, i.e. money flowing automatically into different financial instruments (mutual funds, retirement accounts, etc) every month.

      Taking the automatic route will help release some control and compel us to manage what’s left, increasing the savings rate.

      3. Make a Plan and Vow to Stick With It

      Learning to create a budget is the best way to get around the uncertainty that financial plans always pose. Decide in advance how spending has to be organized

      Nowadays, several money management apps can help you do this automatically.

      At first, you may not be able to stick to your plans completely, but don’t let that become a reason why you stop budgeting entirely.

      Make use of technology solutions you like. Explore options and alternatives that let you make use of the available wallet options, and choose the one that suits you the most. In time, you will get accustomed to making use of these solutions.

      You will find that they make it simpler for you to follow your plan, which would have been difficult otherwise.

      4. Make Savings a Habit and Not a Goal

      In the book Nudge, authors Richard Thaler and Cass Sunstein advocate that, in order to achieve any goal, it should be broken down into habits since habits are more intuitive for people to adapt to.

      Make savings a habit rather than a goal. While it might seem to be counterintuitive to many, there are some deft ways of doing it. For example:

      • Always eat out (if at all) during weekdays rather than weekends. Weekends are more expensive.
      • If you are a travel buff, try to travel during off-season. You’ll spend significantly less.
      • If you go shopping, always look out for coupons and see where can you get the best deal.

      The key point is to imbibe the action that results in savings rather than on the savings itself, which is the outcome. Focusing on the outcome will bring out the feeling of sacrifice, which will be harder to sustain over a period of time.

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      5. Talk About It

      Sticking to the saving schedule (to achieve financial goals) is not an easy journey. There will be many distractions from those who are not aligned with your mission.

      Therefore, in order to stay the course, surround yourself with people who are also on the same bandwagon. Daily discussions with them will keep you motivated to move forward.

      6. Maintain a Journal

      For some people, writing helps a great deal in making sure that they achieve what they plan.

      If you are one of them, maintain a proper journal, where you write down your goals and also jot down the extent to which you managed to meet them. This will help you in reviewing how far you have come and which goals you have met.

      When you have a written commitment on paper, you are going to feel more energized to follow the plan and stick to it. Moreover, it is going to be a lot easier for you to track your progress.

      Making Smart Investments

      Savings by themselves don’t take anyone too far. However, savings, when invested wisely, can do wonders.

      1. Consult a Financial Advisor

      Investment doesn’t come naturally to most of us, so it’s wise to consult a financial advisor.

      Talk to him/her about your financial goals and savings, and then seek advice for the best investment instruments to achieve your goals.

      2. Choose Your Investment Instrument Wisely

      Though your financial advisor will suggest the best investment instruments, it doesn’t hurt to know a bit about the common ones, like a savings account, Roth IRA, and others.

      Just like “no one is born a criminal,” no investment instrument is bad or good. It is the application of that instrument that makes all the difference[2].

      As a general rule, for all your short-term financial goals, choose an investment instrument that has debt nature, for example fixed deposits, debt mutual funds, etc. The reason for going for debt instruments is that chances of capital loss is less compared to equity instruments.

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      3. Compounding Is the Eighth Wonder

      Einstein once remarked about compounding:

      “Compound interest is the eighth wonder of the world. He who understands it, earns it… He who doesn’t… Pays it.”

      Use compound interest when setting financial goals

        Make friends with this wonder kid. The sooner you become friends with it, the quicker you will reach closer to your financial goals.

        Start saving early so that time is on your side to help you bear the fruits of compounding.

        4. Measure, Measure, Measure

        All of us do good when it comes to earning more per month but fail miserably when it comes to measuring the investments and taking stock of how our investments are doing.

        If we don’t measure progress at the right times, we are shooting in the dark. We won’t know if our saving rate is appropriate or not, whether the financial advisor is doing a decent job, or whether we are moving closer to our target.

        Measure everything. If you can’t measure it all yourself, ask your financial advisor to do it for you. But do it!

        The Bottom Line

        Managing your extra money to achieve your short and long-term financial goals

        and live a debt-free life is doable for anyone who is willing to put in the time and effort. Use the tips above to get you started on your path to setting financial goals.

        More Tips on Financial Goals

        Featured photo credit: Micheile Henderson via unsplash.com

        Reference

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