Types of Bill Discounting

 

This is where “Bill Discounting” as a credit facility can come in  as a viable financing solution, allowing businesses to access cash tied up in credit sales, while their  customers pay on due dates or even with slight delays. Putting it simply, Bill discounting, or invoice discounting as it is also called, lets businesses secure immediate funds by “discounting” their unpaid invoices to a lender, usually a bank or an NBFC. BY discounting, it implies that the invoice is financed for its value net of a margin and Interest plus other applicable charges.  Let us understand this more in detail.

What do we mean by Bill / Invoice Discounting?

Bill discounting is a financial service that allows businesses to convert unpaid invoices into immediate cash. This service helps companies maintain a steady cash flow without needing to wait for clients to settle their bills. By offering instant access to funds, bill discounting empowers businesses to keep operations running smoothly, invest in growth, and meet ongoing expenses. Operationally, a business, known as the “drawer,” receives an advance from a lender in exchange for its accounts receivable or bills of exchange. The facility can be with or without recourse to the drawer. Usually, the lender, in turn, collects payment of that bill directly from the buyer (also called the “drawee”) when the bill matures. This arrangement offers businesses quick access to cash without waiting for credit terms to end. The lender draws significant comfort from the credit profile of the buyer here and would normally pre-screen the buyers for a particular drawer for extending credit.

In Simple steps:

• The lender provides funds to the business by deducting a small fee and sometimes keeps a small margin of up to 10-15% as well on the bill.
• When the bill’s due date arrives, the lender collects the payment from the business’s customer.
• If the customer delays payment, the business may have to pay an additional interest rate set in the initial agreement.

Key Players in a Bill Discounting Transaction

Bill discounting involves three main parties:

• Drawer – The business selling goods/services and drawing the bill.
• Drawee – The customer purchasing from the drawer and owing payment.
• Lender/Discounting Agency – The financial institution that advances funds to the drawer.

Does Bill Discounting Benefit Businesses?

Bill discounting provides several clear advantages for managing day-to-day cashflows of the business:

• Improved Cash Flow: Get immediate funds from unpaid invoices, which they can reinvest in operations or new opportunities Instant Access to Funds: A quicker solution to cash flow needs compared to traditional financing options. The process is not being digitised by several lenders and fintech players and requires minimal documentation

• No Collateral Required: Bill discounting uses the unpaid invoice itself as collateral. This means businesses don’t have to risk their assets
• Off-the-Balance-Sheet Financing : Bill discounting does not immediately impact the company’s liabilities on the balance sheet. Since it’s not a loan, it helps businesses access funds without increasing debt or affecting credit scores.

• Confidentiality Options: Businesses can choose confidential arrangements, maintaining customer relations.

Are there any disadvantages of Bill Discounting?

Some of the drawbacks in utilising Bill discounting facilities can be listed as below:

1. Reduced Profit Margins

While bill discounting offers fast cash, it comes at a cost. Banks or financial institutions charge a fee to discount the bill, which can reduce the company’s overall profit margins. Businesses must weigh the cost of this service against its benefits to ensure its financially sustainable.

2. Limited to Commercial Bills

Most financial institutions only discount commercial bills, which can restrict options for certain businesses. Additionally, new businesses may struggle to meet eligibility criteria for bill discounting, making it challenging to access funds without a proven financial track record.

3. Short-Term Solution

Bill discounting is primarily designed as a short-term financing option. It can help cover immediate expenses, but it’s not ideal for long-term financial needs or major investments. For businesses looking for more sustainable funding, other options like loans or equity financing may be better suited.

Interest Rates and Trends

Interest rates for bill discounting vary based on factors such as risk and the specific financial institution. Reputable platforms often offer more competitive rates, making it essential for businesses to explore multiple options. Interestingly, interest rates for bill discounting have been trending downward in recent years, attracting more small and medium-sized enterprises (SMEs) seeking an alternative to traditional loans.

What are the different types of Bill Discounting facilities being offered in India

1. Standard Bill Discounting

Overview

Standard bill discounting, or disclosed discounting, is the most straightforward type. Here, both the business and its customer are aware that a discounting agency is involved. The lender may contact the customer directly when payment is due.

Benefits:

• This option allows businesses to receive funds quickly at a lower cost.
• It’s ideal for companies that need to maintain stable working capital for regular operations.

Drawbacks

Since the arrangement is disclosed, the involvement of a third party may sometimes affect customer relationships.

Cost: The fee for standard bill discounting typically ranges from 0.04% to 3% of the total invoice value.

 

3. Full Turnover Invoice Discounting

Overview

Also known as whole turnover invoice discounting, this type allows businesses to discount all their sales invoices. The business assigns its entire sales ledger to the lender, receiving funds whenever an invoice is raised.

Benefits:

• This option is ideal for companies engaged in long-term contracts, providing consistent cash flow without frequent applications for financing.
• Automated discounting reduces administrative effort and lead time.

Drawbacks

Although convenient, businesses may lose some control over their receivables.

Cost

The rates range between 0.04% and 3% of the invoice value.

4. Partial Turnover Invoice Discounting (Selective Invoice Discounting)

Overview

This option allows businesses to select specific invoices for discounting rather than the entire sales ledger. It offers a more customized financing solution.

Benefits:

• Greater control over which receivables to discount.
• Selective invoice discounting suits businesses with hybrid financing needs.

Drawbacks

Managing selective financing may require more administrative oversight.

Cost

As with other options, fees vary between 0.04% and 3%, depending on the lender.

5. Clean Bill Discounting

Overview

In clean bill discounting, the business receives funds against a bill without providing additional documentation to the lender. It’s a fast and straightforward process.

Benefits:

• The low turnaround time makes it perfect for businesses needing urgent funds.
• Clean bill discounting is flexible, and services can be tailored to the business’s needs.

Drawbacks

The lack of additional documentation could raise the lender’s risk level, potentially impacting costs.

Cost

Typically, fees range from 0.04% to 3%.

6. LC-Backed Bill Discounting

Overview

In LC-backed discounting, funds are advanced against a Letter of Credit (LC) from an international buyer. It’s frequently used in international trade transactions.

Benefits:

• The process requires minimal documentation and has a quick turnaround time.
• LC-backed discounting is especially useful for businesses seeking short-term working capital.

Drawbacks

While it’s beneficial for international transactions, not all businesses may have access to this option.

Cost

Fees vary between 0.04% and 3%, depending on the terms and the lender.

Choosing the Right Bill Discounting Option

When selecting a bill discounting type, businesses should consider:

• Business Needs: Some options are ideal for long-term contracts, while others suit project-based operations.
• Customer Relations: Confidential arrangements may be preferred to avoid impacting relationships.
• Cost Considerations: Fees and interest rates vary, so assessing total costs against business needs is essential.
• Cash Flow Requirements: Some options provide more flexibility, such as selective and clean bill discounting.

Summarizing:

In a world where cash flow is critical, bill discounting provides a flexible financing alternative that allows businesses to make the most of their trade receivables. By choosing the right type of discounting, businesses can enjoy a steady flow of funds, sustain their operations, and invest confidently in future growth.

While Bill discounting can be a game-changer for businesses looking to improve cash flows each type of bill discounting has its unique advantages and trade-offs. Businesses need to weigh their options carefully, considering factors like confidentiality, costs, and long-term growth.