Differences Between Factoring and Bill Discounting
Factoring and bill discounting are two essential short-term invoice financing options that cater to the fund needs of a business against unpaid bills. However, these concepts work differently, and it is pivotal to understand their effectiveness.
Factoring and bill discounting are two distinct financial solutions used by businesses to optimize cash flow and manage working capital.
While both factoring and bill discounting provide immediate access to funds tied up in unpaid invoices, there are a few aspects that distinguish between factoring and bill discounting. These differences lie in the ownership of the invoices, the responsibility for collecting payments, and the degree of involvement of the financial institution. Understanding these distinctions is crucial for businesses to select the most suitable financing option based on their unique needs and circumstances.
What Is Factoring?
Factoring, other than discounting bills of exchange, involves a process where a business sells unpaid invoices to a factoring agency. Upon selling the outstanding book of ledgers, a factor holds the entire credit control process and receives payments directly from the customers.
Businesses often generate a lump sum of up to 80% on choosing to factor as their invoice financing options. This not only helps in meeting an organization’s financial liabilities but supports finances from bad debts.
What Is Bill Or Invoice Discounting?
Bill discounting, also known as invoice discounting, is a process where businesses approach a trade financing company to generate funds against invoices that need to be paid. This approach of invoice discounting serves as an objective to accelerate working capital of a company by improving cash flow management.
This process of invoice discounting maintains complete confidentiality from a business’s customers. Moreover, invoice discounting involves an effortless withdrawal of funds with the facility of a short repayment period. Furthermore, the quick and hassle-free processing of import and export invoice discounting makes it one of the most opted provisions for exporters and importers.
Bill Discounting Process
The below mentioned streamlined steps are followed in the process of bill discounting –
- After delivering goods or services to customers, the business issues an invoice.
- The business then seeks a financial organization like a bank or an NBFC for invoice discounting.
- The financial organization scrutinizes the creditworthiness of both the business and the customer owing money.
- Upon approval, the financial organization acquires the invoice at a reduced price.
- Immediate funds, typically a portion of the total invoice amount, are provided to the business by the financial organization.
- The task of gathering payment from the owing customer remains with the business.
- Once payment is received from the customer, the discounted sum is repaid to the financial organization by the business.
The following sequence of events are followed in the factoring process –
- The business completes the delivery of goods or services to its customers and issues an invoice.
- A factoring agreement is established between the business and a third-party factor.
- The factor evaluates the creditworthiness of both the business and its customers.
- The accounts receivable are then purchased by the factor at a discounted rate.
- The factor immediately provides a portion of the accounts receivable value as funds to the business.
- The collection of payments from the customers is handled by the factor.
- The factor may also offer supplementary services like credit assessments, debt collection, and bookkeeping.
- After receiving payments from the customers, the factor deducts its fees and remits the remaining balance to the business.
Parties in Bill Discounting
In the realm of bill discounting, the key participants are:
Business: The organization that sells its invoices to generate immediate cash.
Financial Institution: The entity that acquires the invoices at a reduced rate and offers instant funding to the business.
Debtor: The business customer responsible for settling the payment for goods or services received.
Parties in Factoring
In the factoring model, the entities involved include:
Business: The firm sells its accounts receivable to acquire immediate funding and other associated services.
Factor: A third-party agency that buys the accounts receivable, provides instant funding to the business, and takes over collections and other functions.
Debtor: The client who has received the goods or services and is obligated to make payment.
Types of Bill Discounting
Bill discounting primarily comes in two variants –
Recourse Bill Discounting
The financial institution can reclaim the discounted sum from the business if the debtor defaults.
Non-Recourse Bill Discounting
Here, the financial institution absorbs the risk of debtor default and cannot recover the amount from the business.
Types of Factoring
Factoring is classified into several types based on the scope of services:
Similar to recourse bill discounting, the risk of debtor non-payment remains with the business.
The factor takes on the risk of debtor default and absorbs any loss.
This allows businesses to factor in individual or a select group of invoices, offering more flexibility.
This package encompasses a wide array of services, such as debt collection, credit screening, and bookkeeping, in addition to instant funding.
Advantages of Bill Discounting
Bill discounting offers various perks, such as –
- Quick Cash Access – Enables businesses to plug cash flow gaps without awaiting invoice settlements.
- Selective Discounting: Businesses can opt to discount specific invoices based on immediate cash needs.
- Collection Control: Businesses maintain authority over collecting payments from debtors.
- Enhanced Liquidity: By turning unpaid invoices into immediate cash, liquidity and working capital management are improved.
Advantages of Factoring
Factoring provides several benefits, such as –
- Immediate Financing: Quick cash access by selling accounts receivable.
- Reduced Admin Load: The factor manages collections, credit assessments, and bookkeeping, lightening the business’s administrative duties.
- Risk Mitigation: In non-recourse arrangements, the factor absorbs the risk of debtor non-payment.
- Improved Credit Analysis: Factors usually possess expertise in credit vetting, aiding businesses in better-evaluating customer creditworthiness.
What Are The Differences Between Factoring And Bill Discounting?
The difference between factoring and bill discounting can be better explained with the help of a table as shown below:
Basis of Difference
Invoice or Bill Discounting
Businesses trade the unpaid bill to trade financing companies and generate payment against those.
A process where a business sells its book debts or outstanding invoices to a financial company.
The bill discounting providers are not vested with any credit control.
In this process, factors gain complete credit control.
The amount that businesses receive from trade financing companies depend on the creditworthiness and accounts receivable of a business.
In this case of factoring, a business can receive up to the amount of the book debts.
The parties involved in bill discounting are drawer, drawee and payee.
The parties involved in factoring are factor, debtor and client.
Invoice discounting service providers maintain complete confidentiality of the agreement, which means customers of a business are not aware of the involvement of any bill discounting company.
There is no level of confidentiality involved in this factoring process, as customers pay directly to the factors.
Recourse and Non-recourse
The Negotiable Instrument Act of 1881
Not specified under any Act
Bill discounting is ideal for medium-sized and big organisations.
Factoring is ideal for small and medium-sized businesses
The table highlighting invoice discounting vs factoring provides knowledge to assist businesses in deciding their selection based on any of the factors. In addition to this, some of the other significant elements that play a crucial role in understanding the suitability of both concepts are:
- Nature and size of the business
- Current status showcasing financial requirements
- Ability to control credit
- The process to be followed to manage the sales ledger
- Optimisation of resources
Generally, many industries dealing in transport, logistics, wholesale, construction, and printing opt for invoice discounting services to raise funds. However, depending on the credit limit of the outstanding bills, businesses choose to factor as their primary invoice financing options.
Factoring and bill discounting are two quintessential financial instruments that not only assist in generating funds from unpaid bills but also accelerate the working capital and cash flow management in a business. In addition, invoice financing platforms like KredX offer end-to-end management by initiating hassle-free and paperless transactions requiring less time.