Imagine this scenario. You are eagerly waiting for your clients to clear your invoice and make the necessary payments, only to discover that it could take a bit longer than anticipated. Not an ideal scenario, right? It puts a massive strain on your small to medium-sized business’s cash flow, compelling you to turn to financial instruments such as bill discounting.
This article sheds light on bill discounting and its types, why companies should leverage it, and whether it is the right strategy in the long run.
What is Bill Discounting?
Bill discounting refers to the process of selling your business’s outstanding debts or accounts receivables to lenders or financial institutions to receive funds for cash flow requirements. This allows your business to fulfil its financial obligations and other operational expenses without any hassles.
Here, lenders may inspect the authenticity of the accounts receivables and the company’s creditworthiness before offering an advance against debts. That said, lenders charge a small commission fee for this, so it is important to note that a company will receive an advance that is less than the bill’s value.
For example, if the value of your accounts receivable is INR 50,000, the value of your advance is likely to be around INR 45,000 (typically around 90% of the bill value).
How Does Bill Discounting Work?
Now that we are familiar with the topic, let’s discover how it works. It involves three parties, including the drawer, the drawee, and the payee.
The drawer is the business that sells goods and services to its customers and is entitled to receive money at a later date. Additionally, the drawer is the party that creates the bills of exchange.
The drawee purchases goods and services, and the liable party to complete payments in the future against that. Therefore, the drawee is the debtor of the drawer in this transaction.
Lender or Discounting Agency
The discounting agency or lenders act as the intermediary in bill discounting transactions and grant funds to the drawer in exchange for the right to collect payments when the bill matures.
In short, all these parties come together to complete a discounting transaction. The financial institutions and lenders make the funds accessible to the sellers, assuming that they will return it when the bill matures.
Types of Bill Discounting
In this section, we will explore the different types of bill discounting that are available in India.
1. Disclosed Bill Discounting
This is also known as standard discounting. This financial instrument includes discounting of bills, money recovery, and a gamut of discounting processes.
In this case, the seller, buyer, and other stakeholders know about the discounting agency’s inclusion in the trade agreement. The company is eligible to approach their client’s customers to recover the bill money once the bill matures.
This is considered to be one of the fastest ways for businesses to discount their bills and access funds to maintain a steady cash flow.
The non-confidential nature of the transaction, coupled with the presence of a third party, may weaken the relationship between the other two parties – the seller and their clients.
2. Undisclosed Bill Discounting
Unlike disclosed bill discounting, the presence of a third party in the transaction is unknown to the seller and their clients. This is why it is also known as confidential discounting.
Here, the discounting agency or the lender handles different aspects of funding and recovery for their clients without informing their client’s customers. As the due date approaches, the customers are liable to make payments to a confidential and controlled account that the discounting company can access.
This approach enables businesses to establish stronger relationships with customers, as the presence of a third party is confidential.
Volatile undisclosed discounting rates in India are between 0.04 % and 3%, which change from lender to lender.
3. Full Turnover Bill Discounting
Some industry experts call it the whole turnover discounting. In this approach, businesses sell their sales ledger to the discounting agency. It is worth noting that many companies automate this process when they receive a bill of exchange, and they can immediately discount it for cash.
Again, this approach is one of the fastest ways businesses can discount their bills and create cash.
Some of the glaring downsides of deploying this solution include stringent credit checks, higher costs, and a plethora of legal complications, to name a few.
4. Partial Turnover Bill Discounting
Partial turnover discounting or selective discounting is part of the whole turnover bill discounting. Here, businesses control the receivables they want to sell to the discounting agency.
While full turnover discounting primarily focuses on continuity, this option is confidential and more control-driven.
Businesses have full control over their trade receivables. Further, they have the liberty to share only relevant information which they deem worth sharing with the invoicing company.
This discounting option can impact immediate cash flow as the drawer only receives a partial amount of the bill’s value. Additionally, cash flow management can become a bit complicated compared to other bill discounting alternatives.
5. Letter of Credit-backed Bill Discounting
As the name suggests, LC-backed discounting primarily involves discounting agencies allocating funds against the letters of credit given to them by their buyers.
One of the main benefits of LC-backed discounting is the simple and straightforward process that requires minimal documentation.
Issuance of letters of credit can incur additional costs to the entire transaction. Additionally, LC-backed discounting is primarily suitable for international trade transactions and not for smaller domestic transactions.
Wrapping It Up
Businesses should realise the benefits and downsides of different types of bill discounting to make informed decisions and implement effective financial strategies to streamline their cash flow. While each billing discount type comes with its fair share of benefits and downsides, businesses should study the intricacies of all types of options to identify the most suitable solution for their unique requirements.
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Get in touch today to learn more.