Bill discounting is a term commonly used in forex markets and international trade. It is basically a method to finance working capital by the seller of assets. It is a service availed from financial institutions like banks for a nominal fee. Bill discounting is the early release of funds. The customer gives the bank a BOD and the bank gives an amount to the customer which is amount of BOD less the bank fee. In case of international trade letter of credit is the widely used mode of payment, and bill discounting is a service associated with LC. Bill discounting is also known as invoice discounting and purchase of bills. It is beneficial as it facilitates the seller or the exporter to avail funds or payment before the expiry of the term of the LC and thus, he can use this amount to finance working capital expenses and ship the goods on time.
The fees charged by the banks in this case depends upon the time left before expiry of LC and he amount of the LC. It is associated with the risk assumed and the credibility of the exporter. It is a beneficial service for both the importer and the exporter of the goods.
There are various advantages that bill discounting provides to various parties involved in international trade.
For the investors, BD is a great way to avail short term finance. There is no restriction on the amount due to the transaction nature of bill discounting. Thus, the investor faces no restriction on the amount being used in case of bill discounting. It helps them to save upon their tax liabilities as it is considered a form of lending. Bill discounting is a flexible tool, allowing flexibility not only upon the amount of funds but also upon the duration of such investments.
In case of banks, a transaction of Bill Discounting provides safety of the funds that it provides to the party exchanging the bill of exchange. Since BOE is a negotiable and tradable instrument which can be enforced in the court of law. Also, BOE being a self-liquidating instrument helps to ensure certain payment to the banks and helps them to plan their resources. Also, the fee charged by the banks to provide this service acts as a source of revenue for banks.
Bill discounting on one hand raises the profits of banks on the other hand reduces the profits of the investors or the person who discounts the bill since that person has to pay the fee leading to less funds being received. Also every bill cannot be discounted. There are a number of financial institutions that provide this service only for commercial bills. Also the bank evaluates a number of parameters before providing the bill discounting service. Also this is a shot term service, one cannot avail long term benefits.
Since banks assess the credit worthiness of the party before providing this service, it is only extended to regular customers and established firms. Bills of exchange can act as a collateral when availing a loan. Thus discounting of bill reduces the amount of collateral available to the firm.
Read more about Letter of Credit