Credit is typically used to make purchases of goods or services, regardless of whether the transaction takes place locally or globally. As a result, ensuring that a healthy cash flow is maintained becomes a significant problem for suppliers.
When purchasing products or services, prospective buyers will constantly ask sellers for trade credit. Therefore, discounting bills of exchange makes it easier for businesses to handle their short-term cash needs, which benefits the suppliers.
This page explains in greater detail what what “bill discounting” or “discounting of bills” is, as well as how the process works.
Discounting Bills of Exchange: Definition
The provision of short-term working capital loans against invoices or bills of exchange by commercial banks or other financial institutions in exchange for a discount on the invoices or bills of exchange is known as bill discounting or the discounting of a bill of exchange.
Funds are often advanced to the vendors at a rate that is lower than the invoice value by the banks and other financial institutions before the funds reach their maturity (due date).
To put it another way, banks will buy the invoice or bill of exchange from the seller and then provide cash to the seller at a value that is lower than the invoice value. The commission or charge that the bank applies to the transaction accounts for the difference in value and is based on the creditworthiness of the buyer as well as the length of time until the bill is due to mature.
After some time has passed, on the date of maturity, commercial banks or institutions will recoup the entire amount from the buyers.
In this scenario, the bill of exchange serves as security for the seller so that they can access short-term loans. It is not necessary for the sellers to produce any extra assets (such as inventory, FD, or other securities) as collateral in order to obtain a loan. As a result, bill discounting and invoice discounting have become the most common methods for acquiring short-term financing.
The Process of Discounting Bills of Exchange
In the process of discounting the bill of exchange, there are three parties involved: the supplier, the buyer, and lending institutions such as commercial banks. There are two distinct approaches to discounting bills.
- For a single transaction only: The seller is granted credit for a single invoice only.
- As a Revolving Credit: If you choose this option, the vendor will provide you with a revolving credit limit that you can use to pay off a certain number of bills within the next year. After some time has passed and the buyer has paid their future invoices in full, the banks will eventually reset the credit limit.
Steps involved in bill discounting.
- The supplier raises an invoice/trade bill against the purchase of goods or services.
- The signature on the bill indicates that the buyer has acknowledged the invoice that was generated for the payment on the due date.
- The supplier approaches commercial banks or other financial institutions like NBFCs for discounting the trade bill.
- Banks or NBFCs critically examine the authenticity of bills and the creditworthiness of the buyer.
- If the bank or NBFC becomes assured regarding the credibility of the buyer, they disburse the amount to the seller after deducting interest or charges.
- Later on the due date, the Bank shall recover the whole amount from the buyer.
Bill Discounting vs. Business Loans
|Parameter||Bill Discounting||Business Loans|
|Purpose||For trading of goods or services|
|For capital fund requirements,|
day to day activities or expansion
|Collateral||Not required, however, need to pledge invoices.||Required (Not required in case of unsecured business loans)|
|Interest Rate||Depends on the maturity date & risk during repayment.||Depends upon nature, scheme and applicant profile, and financial statement.|
|Eligible companies||Medium and large enterprises|
with high turnover and financial stability
|Startups, MSMEs, Private limited companies, manufacturing companies, shopkeepers, etc|
|Nature of loan||Short-term||Long-term, working capital funds|
|Disbursement||Instant, if approved||2-4 working days, if approved|
|Tennure||12 month – 3 years||12 month – 5 years|
|Loan Amount||Invoice value and nature of business||Depends on a variety of factor but max. up to 1 crore|
I really hope that you have a solid grasp of the idea behind discounting bills of exchange. Overall, bill discounting can be thought of as a form of loan that is offered by banks to those who are in the business of selling goods or services. It provides a solution for the sellers of small and medium-sized businesses who have a need for financing in the immediate term. Additionally, it helps to reduce the possibility of bad debt and boost sales.