Factoring And Discounting Of Bills For Smooth Liquidity

  • KredX Editorial Team
  • 18 Feb 21
  • Bill-Discounting,business
A large section of Indian companies struggle to access funds from formal credit facilities. This often makes sustenance cumbersome for most small and medium-sized firms.  Thus, alternative funding options like factoring and bill discounting are gaining currency among businesses looking to resolve cash flow issues. These options are steadily emerging as the industry’s answer to its liquidity problem.  In case you are wondering how invoice discounting and factoring is managing to do so, take a look at their underlying features.  Read on to find more! 

What Is Factoring?

Factoring is when a business sells its book debts to a financier at a discounted rate. You can avail a specific percentage of the bills receivable amount as a cash advance. The remaining balance, you can access once the bill is settled. The primary advantage of factoring is that it offers you freedom from chasing your customers for payment. The financier collects the same on your behalf. However, the feature gives rise to another concern, i.e. lack of confidentiality about the arrangement. It may compromise existing relations with your debtors. Three parties are involved in this arrangement:
  1. Factor
  2. Debtor
  3. Client
In exchange for their factoring services, financiers levy interest and commission. However, you must note two crucial things here. One, if the customer defaults you will be liable to repay it and on top of it, the lender may exercise Pawnee’s right over the supplied goods. Two, as you opt for factoring services, you relinquish control over your sales ledger.  On that note, let us now proceed to find out about bill discounting. 

What Is Discounting Of Bills?

In a nutshell, it can be defined as trading bills of exchange to a financial institution before its maturity date at a discounted price. Based on the customer’s credibility, the financier then extends a percentage of the total bill.  Ideally, there are three parties involved in bill discounting, namely -
  1. Drawer
  2. Drawee
  3. Payee
On maturity, the invoice value is collected by the drawer. This arrangement keeps customers out of the agreement and helps businesses keep it confidential.  Note that once payment is collected from the customer, the financier releases the balance amount after deducting their fees. You continue to control your sales ledger if you opt for bill discounting.  

Impact Of Factoring And Discounting Of Bills On Liquidity Issue 

Now that we have discussed the underlying benefits of bill discounting and factoring, let’s take a quick look at how these options are solving the liquidity crisis of the industry at every step – 
  • Providing Effective Cash Flow Solutions

Unlike traditional funding options, factoring and discounting of bills lay down less stringent eligibility criteria to qualify. The amount of funds you can access through these funding options depends entirely on the invoice value and is not fixed by the lender, which is often not the case in traditional borrowing. This helps businesses access funds and meet their requirements readily and access an amount they would need based on their operations’ scale. 
  • Helps Shorten Working Capital Cycle

Longer the cash cycle, higher is the chance of being subjected to a cash flow crisis. Often, it is not viable to shorten the credit period you offer to your loyal customers. However, maintaining a steady cash flow is also necessary to meet working capital requirements seamlessly.  The great thing about both factoring and bill discounting is that they can help you shorten your operating cycle promptly by releasing a large chunk of the tied-up capital before maturity. This way, you neither have to ask your customers for a quick payment nor struggle with your enterprise’s daily operations due to a liquidity crisis. 
  • Provides Quick Access To Funds

Compared to most traditional forms of funding options, factoring and bill discounting helps businesses  access funds quickly . For instance, trusted invoice discounting platform, KredX, helps businesses raise working capital  against invoices typically between 24 to 72 hours*. 
  • Does Not Create Debt

The best financial advice for any business is that they shouldn’t accrue fresh debt to meet the existing ones.  Fortunately, both factoring and bill discounting help you stick to this advice. These funding options do not necessarily need you to avail a new debt. Instead, they help you to release cash that is tied up in your firm’s unpaid invoices. Thus, it saves you from worrying about any repayments. 

Bottom Line:

Both factoring and bill discounting are excellent means of solving liquidity crises and boosting working capital without any hassle. Though both are a competent source of funding, they are distinct from one another. As a business owner, you need to pick the one that suits your requirements the best and proceed accordingly.