Factoring and Bills Discounting

Bills discounting is traditional method of bank financing. Bill is a promissory note and it can be negotiable. It contains the promise to pay the amount mentioned in it to the drawer/payee on the date of maturity.

Bills Discounting

Definition

“When the seller (drawer) deposits genuine commercial bills and obtains financial accommodation from a bank or financial institution, it is known as “Bill Discounting”. The seller, instead of discounting the bill immediately may choose to wait till the date of maturity”.

Features

Discount charge: The margin between advance granted by the bank and the face value of the bill is called the discount, and is calculated on the maturity value at rate a certain percentage per annum.

Maturity: Maturity of a bill is defined as the date on which payment will fall due. A normal maturity period is 30, 60, 90 or 120 days.

Ready Finance: Bank discount and purchase the bills of their customers so that the customers get immediate finance from bank. They need not wait till the bank collects the payment of the bill

Advantages of Bill Discounting

Easy Access: Bill discounting is beneficial because the seller has access to short term source of finance from the banker, which would help meet urgent business expenses.

Safety of Funds: Bill Discounting offers advantage of safety of funds deployed by the banker.

Certainty of Payment: A discounted bill of exchange being self liquidated in nature, a banker is assured of payment on the date of maturity.

Profitability: Bill discounting offers the benefit of obtaining a yield much higher than other types of loans and advances.

Smooth liquidity: Bill discounting allows for smooth inter-bank liquidity. Development of a healthy bill market helps achieve stability in an otherwise violently fluctuating call money market.

Bill Discounting permits banks to buy and sell bills, and eventually helps even out their liquidity investments.

Higher Yield: The actual yield rate of discounted documentary bills as that are earned by the banks and financial institutions is much higher as compared to discounting of clean bills.

Ideal Investments: To a banker, bill discounting and purchasing offers the advantage of ideal employment of funds for a definite period. As bills are drawn for a definite period the banker can invest surplus funds for an appropriate period.

Facility of Refinancing: Discounted bills serve as the good liquid asset. Banks may always avail themselves of the refinancing facility made available by the approved financial institutions in a country for bills discounted and purchased by them.

Relative stability of Prices: Bills are considered to be less volatile avenues of investments for a banker as compared to other securities. This is because bills do not fluctuate much in their value, although a banker might sometimes have to get them rediscounted at a higher rate.

Steps in Discounting and Purchasing

Examination of Bill: The banker verifies the nature of the bill and the transaction. The banker then ensures that the customer has supplied all required documents along with the bills.

Crediting Customer Accounts: After examining the genuineness of the bill, the banker grants a credit limit, either on a regular or an adhoc basis. The customer account is credited with the net amount of the bill. The amount of discount is the income earned by the bank on discounting.

Control over the accounts: To ensure that no customer borrows more than the sanctioned limit, a separate register is maintained for determining the amount availed by each customer. Separate columns are allotted to show the names of the customers, limits sanctioned, Bills discounted, Bills collected, loans granted and loans granted.

Sending Bills for Collection: The bills, together with documents duly stamped by the banker are sent to the banker’s branch for presenting the bill for acceptance or payment, in accordance with the instructions accompanying the bill.

Action by the Branch: On receipt of payment, the collecting banker remits the payment to the banker which has sent the bill for collection.

Dishonor: In the event of dishonor, the dishonor advice is sent to the drawer of the bill. It would be appropriate for the collecting banker to get the bill protested for dishonor. The banker debits the customer account with the amount of the bill and also all charges incurred due to the dishonor of the bill. Such a bill should not be purchased in the event of its being presented again. However, the banker may agree to accept it for collection.

Let us see the resemblances and contrast between factoring services and bills discounting.

Resemblances

Both provide short-term finance

Accounts Receivables are discounted in both

Contrast