Cash is the lifeline of a business and there are many strategies to help businesses manage their cash flow. Bill Discounting is one of such most effective strategies. There can be serious financial challenges for vendors, in case they have to wait for months to receive payments. Bill Discounting comes to their rescue in this regard by allowing businesses to get their payments quickly by selling their unpaid invoices to a bank or a financial institution at a discount. With this approach, cash becomes available to them easily and helps them run their operations smoothly.
Definition – Bill Discounting
Bill discounting is a method wherein, without waiting for the customers to pay, its accounts receivable, for example bills or invoices, are sold by a business to a bank or financial institution in exchange for immediate payment of cash at a discounted price .. When such bills or invoices become due, full payment is collected from the customer by that Bank or the financial institution,
Process of Bill Discounting
Creation of an Invoice or a bill
When goods or services are provided to a customer by a business, a bill or invoice with a future payment date is created, which includes details like the invoice date, due date, amount and buyer’s information.
Submission to Bank or Financial Institution
The business submits the bill or invoice to the bill discounting provider (e.g., a bank or financial institution),which reviews the invoice to ensure it meets the eligibility criteria.
Verification and Approval
The bills or invoices, as the case may be, are verified by the provider with the buyer to ensure their accuracy and authenticity. Once satisfied creditworthiness of the buyer and the legitimacy of the bill and invoices are approved by the provider for discounting.
Calculation of discount
The discount amount is calculated by the provider taking into account the invoice value, discount rate, and the time period.
Payment to the Seller
Once approved, the funds are disbursed to the seller by the bank minus the discount amount. Thus, immediate payment is received by the seller, improving his cash flow.
Collection from Customer:
When the due date arrives, the full bill amount from the customer is collected by the bank or financial institution.
Settlement
After collecting the full amount from the customer, the provider settles the transaction by retaining its fees and interest, and returning the remaining amount, if any, to the business
An Example of Bill Discounting
Company XYZ Limited is in the business of office stationery and has supplied some office stationery to a Firm namely Ram Enterprises. If the invoice amount is, say it is Rs. 2,00,000. The buyer i.e. Ram Enterprises will make the full payment after 90 days. The discount rate is 12% per annum (1% per month)
But if the money is needed by XYZ Limited before 30 days, Ram Enterprises will issue XYZ Limited a letter of credit from the bank for 30 days. XYZ Limited can approach the bank and collect payment against that invoice much more quickly. To make this ‘advance payment’, the bank will charge some interest from XYZ Limited. So, XYZ Limited will get a discounted amount from the bank. Assuming the discount rate is 3%, the bank will charge you Rs. 6,000 and deposit Rs. 1,94,000 in XYZ’s Limited account. After expiry of 30 days, Rs. 2,00,000 will be collected by the bank from Ram Enterprises.
Thus, in this way, that particular invoice would get settled.
Bill Discounting
Need For Bill Discounting
Improvement in Cash Flows:
Every business – whether big or small – depends on cash flow for survival and growth. This can be done through bill discounting by infusing a quick cash flow into the business. This way, businesses can receive about 90-95% of the invoice value in just a day or two instead of waiting for the customers to pay. Thus businesses are helped to survive and flourish as they can have the cash they need right away to cover expenses and invest, wherever required.
Provides instant access to cash:
Regular cash is required to make payments to suppliers, employees or to cover operational costs. Thus, bill discounting enables companies to manage their cash flow needs effectively, without relying on loans or credit and reducing the risk of bad debts and late payments. .
Investment in new Opportunities:
Bill discounting enhances liquidity, through which businesses can capitalize on available opportunities without waiting for incoming payments.
Reduction in Bad Debts Risk:
By using bill discounting, this risk can be transferred by businesses to the financiers, who then become responsible for collecting the outstanding payments. This helps businesses avoid potential losses from non-payment by customers
Avoidance of Loan Dependency:
Bill discounting being not a loan but a sale of an asset i.e. the receivable, businesses can use it as a more flexible alternative instead of taking on new debt or loans. It does not involve much documentation and the seller is not required to provide any collateral security to get the funds.
Growth and Expansion:
Bill discounting can help businesses invest in growth and meet essential expenses. By converting receivables into cash, necessary funds are always available for businesses to grow and expand their operations.
Difference Between Bill Discounting And Loan
Factor |
Bill Discounting |
Loan |
| Nature | A short-term financing solution
based on receivables. |
Long-term or short-term
financing for various purposes. |
| Speed | Quick within 2-3 days. | It can take time due to
Paperwork and credit checks |
| Mode | Generally manually | Completely digital |
| Collateral | Collateral such as property or
other assets not required as the bill serves as security. |
Require collateral or |
| History of
Credit |
It focuses on the reliability
of one’s customer’s credit history. |
It focuses on the reliability
of one’s own credit history. |
| Repayment | When the bill matures,
payment is made by the debtor and the balance is settled by the financial institution.. |
Repayment is made in
instalments over a fixed period regardless of business performance. |
| Interest
Charges |
The financial institution
charges a discount rate based on the maturity period of the bill.. |
Loans incur interest charges
based on the principal amount. |
| Fees | Invoice discounting fees can be
higher than loan interest rates. |
loan interest rates can lower
than Invoice discounting fees. |
| Purpose | Primarily used for working
capital or short-term financing. |
Used for long-term
investment or ongoing business expenses. |
| Approval | The approval process is
faster, typically based on the debtor’s creditworthiness. |
The loan approval
process is usually more complex and involves detailed financial analysis. |
Criteria for Eligibility
Tenure of the Business:
It is important that the business should have been in existence for a reasonable period of time. It is easier for established businesses, which have a track record of operations, to get their bills discounted.
Age/Nature of Receivables:
Banks and financial institutions are less likely to discount near-maturity or overdue bills. Thus, receivables should not be too old. Further, a bill of exchange or promissory note should be issued for goods or services provided to a trusted customer.
Creditworthiness:
The business must have a strong credit history and the customers i.e. debtors should also be reputable and have a proven track record of making payments timely.
Reputation of the Business:
The popularity of the business and its standing in the market are also key factors in this respect.
Invoice Value:
Financial institutions often set a minimum invoice threshold for bill discounting.
Requirement Of Documents
- Business Registration Documents: Proof of the business’s legal standing
- Business PAN card and address proof
- Applicant’s Aadhar card.
- GST Returns
- Financial statement with an audit report and Income tax return .
- Passport-sized photographs and duly filled application form
- Last 12 months’ bank statements
- Bill of Exchange or Promissory Note: A copy of the bill to be discounted, including terms and conditions.
- Letter of Credit
- Commercial Invoice
- Packing list with all the details
- Details of Logistics with a copy of the delivery note, if any
- Submission of proof of certificates, registrations, licenses, and permits, if any
- Any other document which may be required
How To Apply For Bill Discounting
Following are the steps to apply for Bill Discounting:
Selection of an Ideal Financial Institution
It is absolutely necessary that for bill discounting the right financial institution or bank may be chosen in order to optimize cash flow management. This can be achieved by conducting a thorough review of the various terms and conditions of different institutions including:
• Discount rates, which should be competitive
• Criteria of Eligibility
• Associated fees
After comparing all these factors, an informed decision can be made by a business and selection of the financial institution that best aligns with their needs can be made.
Required Documents Collection
Next, the collection of all the necessary documents is to be made like, Bill of exchange
- Invoices
- Proof of delivery
- Financial statements
- KYC documents
This will help expediting the application process
Submission of the Application
After collection of the necessary documents, the bill discounting application can be submitted to the selected financial institution or bank whether online or by in-person submissions, based on the facility available.
Evaluation of Creditworthiness
Creditworthiness of both the business and the debtor shall be evaluated by making an assessment of the bill by the financial institution or the bank, as the case may be. This may involve reviewing
- payment history of the debtor,
- financial standing, and
- the financial health of the business
Signing the Agreement
If the bill discounting request is approved, an agreement is signed outlining the
- discounting arrangement, including
- the discount rate,
- payment timelines, and
- fees.
Receiving the Discounted Amount
After signing of the agreement, an upfront payment, typically 80-90% of the bill value, is provided to the business by the financial institution. The remaining balance is paid to the business after the debtor settles the bill.
Final Settlement
When payment is made by the debtor, its fees and interest are deducted by the financial institution and the remaining amount is returned to the business completing the bill discounting arrangement.
Advantages of Bill Discounting
Immediate Cash
Immediate cash is provided by bill discounting to businesses by converting accounts receivable into cash.
No Collateral Required
Businesses are not required to offer assets as collateral to the lender. Thus, businesses are not required to pledge any real estate, inventory, machinery, or the like.
Credit profile
A business’s credit profile can be improved through regular use of bill discounting, which can unlock more favorable financing opportunities in the future.
Confidentiality Maintained
Businesses can access funds without disclosing financial information to their clients or suppliers. Thus, confidentiality is preserved.
Expansion of Business
Business owners can redirect their focus on expansion and development by leveraging bill discounting,
Disadvantages of Bill Discounting
The process of bill discounting has some disadvantages as also certain inherent risks like
Cost:
Cost of funds makes Bill Discounting more expensive as compared to other financing options like bank overdrafts or credit cards.
Bad Debt Risk:
There may be a risk that the buyer may fail to pay or become insolvent, which can impact the business’s cash flow.
Risks of other types:
There may be a risk of fraud or illegitimacy of transactions during bill discounting.
Conclusion:
Every business needs money to run its operations. Under this option, there is no need for additional collateral, with the result that there is minimal impact on the company’s existing assets. Bill discounting helps businesses obtain immediate cash by selling their receivables like invoices or bills of exchange, to a bank or financial institution at a discounted rate. Therefore, while bill discounting offers short-term financial flexibility, businesses must carefully assess the costs, risks, and their long-term cash flow management strategy, before opting for this financing option.
Bill Discounting also helps in maintaining operational continuity and there is no pressure on the business to follow overdue payments. . This can be especially vital for those businesses which have large volumes of receivables or which are operating in industries where payment cycles are long.. Also, bill discounting can be a strategic tool for those businesses which are keen to enhance their working capital without taking on long-term debt. However, as there are chances of eroding profit margins over time, it has to be ensured by businesses that they properly manage the associated costs of discounting