Bill discounting vs Bill purchase: A ‘Bill’, or Bill of Exchange in India is a negotiable instrument as per the Negotiable Instruments Act, 1881.
Whenever a company sells products to another company and is not paid for the same at that moment, the seller can draw or issue a Bill of Exchange or ‘Bill’ upon the buyer. The ‘bill’ obligates the buyer to make payment at a later date. This bill serves as proof of income at a later date and can be used by the seller for its financial requirements.
The main difference between a Bill Discounting and a Bill Purchase is how a trade receivable or ‘bill’ is treated. In Bill Discounting, the ‘Bill’ or outstanding receipt is treated as proof of future income, and a loan is sanctioned against the bill or unpaid invoices to finance the company’s needs for order fulfilment.
In Bill Purchase, the bill is treated as an asset and bought by a third-party, often known as a Factor.
Let us understand what these terms mean and explore bill discounting vs bill purchase differences.
What is Bill Discounting?
Bill Discounting is a process wherein a company takes their unpaid invoices to a financial institution and takes a loan against them to finance their immediate capital requirements. The credit sanctioned could either be utilized for order completion or other administrative expenditure. The creditor would also deduct some discounting charges while disbursing the loan. Once the order is fulfilled and the company receives payment from its client(s) against its unpaid invoices, it repays the financial institution.
Thus, credit control, or the right and responsibility to collect payment remains with the company in the case of bill discounting.
However, the bills discounted are not to be considered loans and advances under the Income Tax Act, according to a Supreme Court judgment.
The process of Bill Discounting is governed by the Negotiable Instruments Act, 1881.
How does Bill Discounting work?
Let’s say that Company X has received an order amounting to Rs. 10,00,000 from client Y.
However, the payment for the same is to be done upon order completion.
Due to some financial constraints, Company X does not have the required raw material to fulfil that order.
In such a scenario, Company X would go to a financial institution, NBFC A to discount its bill/unpaid invoice.
The NBFC upon validating the invoice and checking Company X’s past credit history and score would sanction a loan of Rs. 10,00,000 to Company X to help it fulfill the order. In that process, NBFC A would also deduct some discounting charges, and hence, it would credit an amount lesser than the total order value before the due date of the invoice.
With the money received, Company X can now purchase the raw material required and fulfil its order.
Once Company X receives the amount due from client Y against the order, it would repay the loan taken by it from NBFC A.
[Note: In India, financial institutions may also ask for NOCs from the the client to discount the trade receivables of a company].
Suggested Read: How To Get Equipment Financing For Business
What is a Bill Purchase?
Bill Purchase, also known as Bill Factoring is a process wherein a company sells its outstanding invoices to a third-party, also known as a ‘Factor’ to fund its immediate capital requirements.
Once the invoice is sold to the Factor, the responsibility of realization of the amount is also transferred to the third party or Factor. The Factor disburses a part of the total outstanding amount to the company upfront, and the rest is released once the amount is realized. While doing so, the factor would deduct its factoring charges as well as the expenditure it incurred for the realization of the amount.
The process of a Bill Purchase is governed by the Factoring Regulation Act, 2011.
How does a Bill Purchase work?
Let’s say Company X has received an order amounting to Rs. 10,00,000 from client Y with the condition that full payment would be made upon completion.
However, Company X does not have the capital for its day-to-day expenditure which could hamper its projects and put outstanding orders in jeopardy.
In such a scenario, Company X would go to a financial institution, NBFC A and decide to forgo the payment from client Y on order completion and sell the outstanding invoice/trade receivables to NBFC A.
NBFC A, also known as a Factor, would buy the outstanding invoice from Company X upon ensuring that the invoice is authentic. Then, NBFC A would pay a specific percentage of the amount due from Client Y to Company X before the due date of the invoice.
With that, Credit control would also shift to NBFC A, ie. it would be responsible for realizing the amount from Client Y.
Once Company X fulfils the order, client Y would pay NBFC A the amount due and in return, NBFC A would release the leftover amount to Company X after deducting its Factoring charges.
Bill Discounting vs Bill Purchase: Which one is better?
| Bill Discounting | Bill Purchase |
| Credit is disbursed against the proof of outstanding invoices of a company and the lender is paid upon order completion. | A third party, or a Factor buys a company’s outstanding invoices and a percentage of it is paid upfront. |
| The responsibility of the amount realization (credit control) from the client remains with the company. | The responsibility of realization from the client (credit control) is shifted to the Factor or third party. |
| The client does not know that the company has discounted the invoice. | The client gets to know that the company has factored the invoice. |
| A loan is disbursed against the proof of invoice. | No loan is disbursed. |
| Fees charged is less as the risk of non-payment remains with the company and not the lender. | Fees charged is higher since the Factor has the additional responsibility of realization as well as an added risk of non-payment. |
| A credit check of the client may not be conducted. | A credit check of the client becomes necessary and the Factor may decline to purchase a bill of a risky client. |
| The customer relationship remains intact and unaffected since the client is not privy to the fact that the company has discounted the bill. | The customer relationship may get hampered depending upon its experience with the Factor. |
Which one should you go for: Bill Discounting or Bill Purchase?
The suitability of the two processes depends upon the values, strengths, and weaknesses of the enterprises.
For an enterprise that may find amount collection/realizations a costly affair due to inefficient logistics, Bill Purchase seems like a suitable option. On the downside, it may affect their relationship with the customers depending upon how the experience of the customer is with the Factor purchasing the bills.
For an enterprise that values customer experience, and is also an important factor in their business model, Bill Discounting would be the suitable recourse since the customer isn’t privy to the details throughout the Bill Discounting process.
Irrespective of which option an enterprise opts for, both of them address cash flow issues of businesses and ensure they have sufficient funds to meet their working capital needs.
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FAQs
Is Bill Discounting secured or unsecured?
Bill discounting is unsecured or collateral-free.
Is Bill Discounting considered a loan?
Bill discounting may be considered a short-term loan since credit is offered against the proof of an invoice.
What is the difference between Bill Discounting and Invoice Discounting?
While Invoice Discounting is offered only against unpaid invoices, a Bill Discounting is offered against any/all Bills of Exchange. The repayment period for Invoice Discounting is 90 days, while it is 30-120 days for Bill Discounting.
Is GST applicable on the processing fee of a Bill Purchase?
Yes, GST is applicable on the processing fee of a Bill Purchase.
What is TReDS?
TReDS or Trade Receivables electronic Discounting System is an online platform regulated by the RBI for discounting trade receivables. It was started as a joint venture between NSE and SIDBI to provide registered MSMEs an avenue for invoice financing.
