It is a trade-related activity in which a company’s unpaid invoices which are due to be paid at a future date are sold to a financier.
In bill discounting, the business trades the company’s unpaid invoices to gain access to short-term financial assistance and maintain the working capital. It is mostly pertinent in cases when a buyer purchases goods from the seller, and the payment is made through a letter of credit. This process is also called “Invoice Discounting”. This process is governed by the negotiable instrument act, 1881.
Features of Bill Discounting
1. Credit Evaluation
A bank will consider the goodwill of the seller as well as the past payment records of the buyer who needs to pay to the bank.
2. Banking Partners
The buyer, who is partnering with a good bank, and has a Good Credit Score, will ensure your bank that the paying party is reliable. The endorsement from the buyer’s bank will work in your favor.
3. Bank to Bank Dealing
Invoice financing transaction happens between banks where the buyer’s bank doesn’t need to intimate the seller of the reimbursement instruction. It deals, directly, with his bank, to determine the discounting terms.
Types of Invoice Discounting
When it comes to invoice discounting, there are a few types that you can choose to maintain a steady flow of working capital.
- Whole Turnover Invoice Discounting
With this type of funding against an invoice, every invoice that a business generates across the turnover is discounted to raise funds, irrespective of the needs of the said business.
- Confidential Invoice Discounting
Like its name suggests, with this type of financing, the entire process is carried out in confidentiality. It means that suppliers or customers of a company are unaware of the business raising capital against invoices before payment is received.
- Selective Invoice Discounting
Spot factoring or selective invoice discounting are some of the examples where single receivable invoices are sold to third parties to raise capital. These are the three principal types of invoice discounting which help companies acquire working capital for their businesses without hassle.
Documents Required for Bill/Invoice Discounting
- Duly filled application form with passport-sized photographs
- Business PAN card and address proof
- Applicant’s Aadhar card
- Business Establishment Proof
- Last 12 months’ bank statement
- Bill of Exchange
- Letter of Credit
- Commercial Invoice
- Packing list with all the details
- Logistics details with delivery challan, if any
- Proof of certificates, registrations, licenses, and permits, if any
- Any other document required
- The business should be a minimum of 10 months old
- Should have dealt with at least 2 large-scale corporate
- Credit score should be 650 or more
- The business ought to have a base turnover of 25 lakhs
Advantages of Bill Discounting
Bill discounting is advantageous to businesses, banks, finance companies, and investors. Businesses benefit by rejuvenating their cash-flow in-turn helping them stabilise growth and fund business expenditure.
- Cash flow: Businesses being dependent on the cash flow to sustain their business can easily rely on this quick financial aid to access speedy funds and continue to flourish. This process quickens money inflow profiting the organisation in expanding deals, seeking after development, securing hardware, etc.
- Instant access to cash: Bill discounting is a more efficient, faster way of assessing working capital as it is hassle-free and does not involve lengthy documentation procedure.
- No collateral involved: There is no requirement to keep any asset as security as the unpaid invoice is considered as the collateral itself.
- No debt incurred: Bill discounting helps in saving tax liability. The chances of a company suffering any loss or damage are almost nonexistent when compared to conventional financing frameworks.
- No impact on business sheet: Bill discounting service does not impact the balance sheet of the business as it is an off-the-book process
Disadvantages of Bill Discounting
- Invoice discounting reduces the investor’s gross profit margin as the bank deducts a huge amount as a fee while discounting bills.
- Most of the financial institutes discount only commercial bills.
- It cannot be thought to be a long term solution for finance as is only a source of short-term fund arrangement.
- New businesses might not be eligible.
Bill Discounting Rate of Interest
The interest rate offered by financial institutions on bill discounting depends on factors that include business stability, financial history, business volume, business tenure, applicant’s credit score, or creditworthiness along with his/her financials.
Business becomes more competitive for buyers and Sellers as they get to enjoy a much lower rate of interest on TReDS platform. Varying from 5% to 8% as opposed to market standard of 15% to 24% PA.
Process of Bill Discounting
- Invoices are being raised when the seller sells the goods on credit
- Accepting the invoice means, that the buyer has acknowledged paying the amount on the due date
- For discounting purposes, the seller approaches the financial institution
- As per the creditworthiness of the buyer and legitimacy of the bill, the bank or NBFC is assured
- Bank or NBFC disburses the fund to the seller post deducting the fee, discount, and appropriate margin which is already defined
- Furthermore, the seller receives the funds which can be used for other business purposes
5 Things Investor should know about Invoice Discounting
Here are 5 things you should keep in mind:
- Higher the return, higher the risk
- In case of a default, business owes the responsibility of Repayment
- You can invest in Invoice Partially
- Be aware of Fees
- There is no prepayment penalty