What Is The Difference Between Bill Discounting And Bill Purchase?
Steady cash flow is critical to keep operations of any business enterprise running smoothly and for its overall growth. Unsettled bills can, however, often hinder the regularity in receiving cash or fund. You can thus leverage the unpaid invoices in your books to secure funds immediately via bill financing.
It’s a broad term with two primary subsets, bill discounting and bill purchase or factoring. Understanding the difference between them is crucial to ensure that you seek the one most suitable for your business requirements. Take a look!
In finance, bill discounting and bill purchase are two different methods of obtaining funds by using invoices in bills of exchange as collateral. Although they are similar in nature, there are some key differences between them. Here’s a breakdown of each.
Bill Discounting Vs Bill Purchase: Definition
In a bill discounting facility, a business leverages its invoices with a third-party – generally, a financial institution – to avail cash advance at a discounted rate.
In bill discounting, a seller presents a bill of exchange to a bank before its due date. The bank pays the seller a reduced amount (less than the bill’s face value) called the discounted value. The seller is responsible for collecting the full amount from the buyer (drawee) on the bill’s maturity date.
For example, your books carry trade receivables worth Rs. 1 lakh. You provide the corresponding invoices to a financial institution, and it agrees to advance 95% of the book value, i.e. Rs. 95,000, as a loan.
Also, your customers or debtors would not know that the receivables are leveraged to avail credit. Thus, you retain credit control and responsibility to collect payments from your customers/debtors.
Bill purchase or invoice factoring involves a similar financing process virtually. The business sells its in-arrear bills to a financial institution, called the factor, which provides cash advances at a discounted rate against such invoice value.
In bill purchase, a seller sells the bill of exchange to a bank before its maturity date. The bank pays the seller an amount less than the face value of the bill, known as the purchase price. The bank assumes the responsibility of collecting the full amount from the buyer (drawee) when the bill matures. The profit for the bank is the difference between the face value and the purchase price.
Under invoice factoring, though, the factor assumes credit control and the responsibility to recover payments from your customers/debtors. Thus, in this case, your business debtors are aware that you’ve leveraged their invoices with a third party to raise funds.
This is the primary difference between bill purchase and bill discounting. In one case, you retain the credit control, in another, the factor assumes it.
Key Differences Between Bill Purchase and Bill Discounting
- Bill discounting involves the bank providing funds to the seller based on the discounted value, while bill purchase involves the bank purchasing the bill from the seller for the purchase price.
- In bill discounting, the seller is still responsible for collecting payment from the buyer when the bill matures, whereas, in bill purchase, the bank assumes the responsibility of collecting the payment.
- Bill discounting involves deducting a discount from the face value of the bill, while bill purchase involves buying the bill at a price lower than the face value.
Both bill discounting and bill purchase offer sellers immediate funds, but the main difference lies in who takes the responsibility for collecting payment and the financial arrangement between the bank and the seller.
How Do They Work: Bill Discounting vs Bill Purchase?
1. Invoice Discounting
- Your business prepares invoices against the credit sale of goods or services.
- You share the invoice details and corresponding bills with your lender.
- This institution assesses the invoices and provides cash advances at a discounted rate against their value.
- Your business’s credit controller then sets to collect payments from the debtors.
- When the invoices are settled, you repay the lender such a loan amount.
The cash advance you receive via the bill discounting facility does not involve any spending constraints. Thus, you can channel this fund for any purpose, like paying suppliers, undertaking a new venture, etc.
2. Bill Purchase
- Invoice is generated against the sale of goods and services on credit.
- You sell the bills to the factor.
- This financial institution analyses the invoices and provides a percentage, let’s say 80% of their value as a cash advance.
- Such a lender then initiates the payment collection process.
- When your customers or debtors clear up payment, the factor forwards you the remaining 20% of the invoice value, minus the service fee or interest.
Similar to bill discounting, there’s no end-use restriction involved with the invoice factoring facility.
Pros And Cons Of Bill Discounting And Purchase
Some common advantages of both these financing options are:
- They provide access to instant financing without any collateral.
- Businesses can streamline their cash flow with ease and efficiency, especially if credit terms vary across clients.
- They do not encumber the finances of a business.
Apart from this, when considering whether to go with bill discounting or purchase, take a look at the following points
1. Customer Relationship
With bill discounting, you undertake the responsibility of outstanding payment collection from your customers. Since it is confidential, your customer relationship remains unaffected.
In the case of bill factoring, the lender collects the outstanding payment. Thus, your customer relationship may be affected.
2. Payment Collection
Your business may benefit from the expertise of a lending institution in terms of payment collection, but that may not always be the case. Thus, you may opt to go with bill purchases if you think their payment collection process can be more effective than otherwise.
On the other hand, you might choose to stick with bill discounting if you wish to retain the responsibility to collect payments from debtors.
Now that you are aware of the points of difference between bill purchase and bill discounting and its implication on your business, it’ll be easier to decide which invoice financing option will maximize your benefits.
In conclusion, the main difference between bill discounting and bill purchase lies in the financial arrangement and responsibility for collecting payment.
In both cases, sellers receive immediate funds, but bill discounting requires the seller to collect a payment, while bill purchase transfers the responsibility to the bank. The choice between these methods depends on the seller’s preference, financial needs, and the terms offered by the financial institution.