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The terms ‘invoice discounting’ or ‘bills discounting’ or ‘purchase of bills’ are all same. Invoice discounting is a source of working capital finance for the seller of goods on credit. Bill discounting is an arrangement whereby the seller recovers an amount of sales bill from the financial intermediaries before it is due. Such intermediaries charge a fee for the service. From the other side, it is a business vertical for all types of financial intermediaries such as banks, financial institutions, NBFCs, etc.
Definition / Meaning of Bill Discounting or Invoice Discounting
Invoice discounting can be technically defined as the selling of bill to invoice discounting company before the due date of payment at a value which is less than the invoice amount. The difference between the bill amount and the amount paid is the fee of the invoice discounting company. The fee will depend on the period left before payment date and the perceived risk.
The bills or invoices under bill discounting are legally the ‘bill of exchange’. A bill of exchange is a negotiable instrument which is negotiable mere by endorsing the name. Our currency is a bill of exchange for example. Currency provides value written over it to the bearer of the instrument. In the case of bill discounting, such bills can be either payable to the bearer or payable to order. Therefore, after discounting a bill, a bank can further get the bill rediscounted from other banks in case of cash flow requirement.
Why Invoice Discounting?
The buyers and sellers of goods have conflicting objectives. The seller wishes to get paid immediately and the buyer wants as longer credit period as possible. Invoice discounting is the solution to the problem which creates a win-win situation. The seller gets his money almost instantly on payment of a small charge and is able to satisfy its customer with credit period. The invoice discounting is an easy way of getting finance. There are no hassles of sanctions etc.
Bill Discounting or Invoice Discounting Process/Procedure
The process of bill discounting is simple and logical.
- The seller sells the goods on credit and raises invoice on the buyer.
- The buyer accepts the invoice. By accepting, the buyer acknowledges paying on the due date.
- Seller approaches the financing company to discount it.
- The financing company assures itself of the legitimacy of the bill and creditworthiness of the buyer.
- The financing company avails the fund to the seller after deducting appropriate margin, discount and fee as per the norms.
- The seller gets the funds and uses it for further business.
- On the due date of payment, the financial intermediary or the seller collects the money from the buyer. ‘Who will collect the money’ depends on the agreement between the seller and financing company.
Advantages of Bill / Invoice Discounting
The business gets the cash instantaneously giving business cycle a better momentum. It allows an entrepreneur to do business without funds. This works like a bank overdraft, the borrower pays the interest only on the amount of money utilized. There is a tough competition in the market to extend such credit and hence there are a plenty of different products to suit the needs of the client. There are borrowers who even cover the risk of bad debt along with the service. Obviously, the charge may be little more.
Disadvantages of Bill / Invoice Discounting
It can be an expensive form of financing compared to other modes of financing such as bank overdraft etc. In many countries like India, where the central bank encouraged the scheme of bill discounting and allowed a lower percentage of interest. But, it was not successful due to various misuses by financing brokers, banks etc.
Suppose there are two sister companies A & B, A draws bill on B without any judicious transaction. B accepts it and A discounts it with the bank and utilizes the credit illegitimately. If the intentions are bad, A & B may default on payment and the banks will have to suffer.
Note: Situation of invoice discounting is different in different countries. The norms of financing differ in different countries and they are different with different borrowers of the same countries as well. This depends on the business policies of the banks and financial institutions engaging in the discounting business.Last updated on : August 31st, 2017