Invoice financing is among the most prominent forms of short-term borrowing, which is based on the sum of money customers owe to the lender or bank. Factoring and invoice discounting both are quite similar concepts, and are the key methods of invoice finance. Through these short-term finance options, the financial requirements of a business can be fulfilled swiftly. While factoring is linked with the management of book debts bill invoicing or discounting is related to the borrowings made from commercial bank banks. Typically, well-established and large-scale businesses go for invoice discounting and the others opt for factoring. There are several bill discounting NBFC (Non-Banking Financial Companies) from home modern firms choose to seek out advantageous invoice discounting solutions.
Factoring involves all of the trade debts of the customer. However, in the case of invoice discounting, only the trade debts that are supported by account receivables are included. In the latter option, the customers have to make payments prior to the due date, while having a discount less than the actual rate. Whereas in the former invoice finance method, the customers give their book debts to the bank or financial institution along with the discount.
Bill Discounting vs. Factoring: At A Glance
Business organizations require funds on both short- and long-term basis. The methods of factoring and invoice discounting are ideal for cases when firms need to achieve their short-term goals.
Trading bill prior becomes due for payment at a price that is lesser than its face value.
|Financial transaction where a firm sells its book debt to a financial institution or bank at a discount|
|Governing statute||Comes under Negotiable instrument act, 1881.||Does not come under any particular statute of law|
|Settlement of finance||
The bill is both discounted and paid at the time of the transaction.
Financer provides a max amount as an advance during the transaction, and pays the remaining sum at the time of settlement.
|Parties involved||● Drawer
|● Factoring company
|Type||Recourse only||Recourse and Non Recourse|
A Fee is charged by the financer in the form of interest or discounting expense.
The fee acquired by the financer is the form of commission for any extra services and the interest for the financial services.
|Assignment of Debts||No||Yes|
What Is Meant By Bill Discounting?
In the words of a layman, bill or invoice discounting simply implies the fee that the bank needs from the seller, if they are willing to sell off the credit bills prior to the credit period’s deadline. The bill is sold or traded at a price that is lesser than its par value. Discount given on the bill of exchange essentially is based on the risks involved in it and the time remaining for its maturity. The method of invoice discounting is commonly used to improve the cash flow position and working capital of a firm. Bill discountingNBFC solutions can especially prove to be quite fruitful in improving the overall financial condition of a firm on a short-term basis, in quite a seamless and hassle-free manner.
The Bill Discounting Process
- 1st Step: The bank must satisfy itself in regards to the drawer’s credibility, prior to giving money.
- 2nd Step: The bank shall deduct a certain discount or fees from the granted sum of money, and give the remaining amount.
- 3rd step: After the bank makes the purchase of the bill of discounting, it shall become the owner of the bills. In case the customer ends up delaying their payments, they would have to pay an interest amount to the bank at the rates directed.
4th step: In the scenario that the customers do not pay their bill on time and end up being defaulters, then the bank shall have right over the services or goods provided by the borrower to the customer.
What Is Meant By Factoring?
In factoring, the client or borrower ‘sells’ off their outstanding invoices to a particular 3rd party commercial finance firm. Factoring deals in account receivables or invoices. The relevant factoring company would deduct the interest changes made on the financial services, as well as commission charges for certain additional services. Here the customer provides the instruction to transmit payment to the factoring company directly and settle their due balance.
The Factoring Process
- 1st step: The Initial account setup of the account, which would take one to two weeks and the completion of various formalities. These formalities include filing of clients, reporting of invoices, and submitting an application.
- 2nd step: Ongoing funding is the second step of the factoring It involves detailed underwriting during the period of time where the factoring company seeks out additional papers like bank statements and paper of incorporation. If they are ultimately approved, then the business shall get a maximum credit line to draw from.
Key Factors Differentiating Bill Discounting and Factoring
Even though bill discounting and factoring both involve borrowing against debt, their processes work in a distinguished manner. Here are the two major aspects on which they differ:
Visibility And Control
- The finance company or bank takes management of the credit control process and the debtor’s sales ledger, in factoring. They actively chase customer payments on their behalf as well. Hence, the debtor can do away with the expenses and time involved on credit checking of the customers.
- In bill discounting, the drawer shall have to manage their own ledgers and collect their payments. As the drawer would get to control their firm’s processes in this system, their customers shall not be aware of the invoice discounting agreement. This helps in retaining superior customer trust.
Adjustments To Advances And Funds Available
- The debtor is given funds in advance for individual invoices in factoring. Any adjustments to the fund received by the debtor are made on a daily basis.
- The drawer shall have to provide a monthly reconciliation of the account that underlines any changes in the debt level to be disallowed in the bill discounting The financer provider would subsequently make adjustments on this basis. This system can lead to larger adjustments, rather than small daily adjustments.
Bill discounting and factoring both have their own pros and cons, and distinctive features. Among them, invoice discounting is especially considered to be ideal for large scale businesses as they have an already proven and established credit control processes. Bill discountingenables these firms to protect customer relationships competently.