Bill discounting refers to a method of working capital finance for the seller of goods. It refers to a fee charged by the bank from the seller of the goods to release funds before the end of the credit period. The bill is presented to the customer and the amount is collected by the bank. It is mostly applicable in cases where letter of credit is used as a mode of payment. Bill discounting is also commonly known as invoice discounting or the purchase of bills. It is a major trading activity wherein the seller of the goods gets funds before the term of the letter of credit expires for a small amount charged by the bank as fees. The fee paid by the seller to the bank or the financial intermediary usually depends upon the time left before maturity of letter of credit for which the bill is discounted and the risk perceived. It also depends a great deal over the credit worthiness of the seller and the past payment history of the buyer of goods.
Bill Discounting acts as a win win situation for both seller and buyer of the goods as the buyer gets sufficient amount of time to make payment against the letter of credit on the other hand the seller gets the payment for goods delivered at the required early date.
Advantages of Bill Discounting
There are various advantages of bill discounting to investors, banks and finance companies.
For Investors, Bill discounting acts as a great source of short-term finance that is available in the market. Bill discounting is outside the purview of section 370 of the Indian companies act 2013, which restricts the amount of loan that can be given by group companies. This is due to the transaction nature of bill discounting. Thus, the amount of loan is not restricted in case of bill discounting being used by the investor. It helps to save tax liability, Bill discounting being in form of lending saves tax at source from being deducted while making payment charges which is very friendly and convenient not only from the cash view point but also from the view of the companies that do not wish to envisage tax liabilities. Bill discounting allows flexibility not only in the amount but also in the duration of the investments
For banks, a bill discounting transaction provides safety of funds since a bill of exchange is a negotiable instrument which is legally enforceable bearing signatures of both the parties. A bill f exchange is a self-liquidating instrument and hence bill discounting ensures certainty of payment and provides great control over their drawals. Discount on a bill earns higher profits for a bank than other forms of loans and advances. Hence it is highly profitable.
Disadvantages of Bill discounting
Discounting of a bill reduces the profit margin for the investor or the person who discounts the bill with the bank. This happens because the bank or the financial institution deducts a portion of the total amount as fee. Every bill cannot be discounted, many financial institutions discount only commercial bills. The discounting of a bill is also subject to the evaluations made by the bank based upon various parameters. Bill discounting can work as a short-term finance but not as a long-term advance.
Bill discounting is a service that is usually made available to regular customers and established businesses by the banks and other financial institutions. This service might not be available to new businesses. Bill of exchange can work as a collateral to avail loans. Discounting a bill reduces the amount of collateral available.
Get more about Discounting Charges on Letter of Credit