On both short-term and long-term basis companies need funds. If one wants to achieve short-term requirements, companies tend to follow the ways of bill discounting and factoring.
In
bill discounting, one can have complete control of your business because you
are responsible for administrating your sales ledger. To keep the cost of
borrowing down the dues are paid and invoices are collected.
In invoice factoring, to help a business there are value-added services. It also helps that person’s business to collect the due amount from his commercial partners which makes repayment of his own financed loan easier.
Bill Discounting vs Factoring
The main difference between Bill Discounting and Factoring is that while bill discounting is the amount which the client pays before the due date with a discount less than the actual rate on the other hand factoring means the client gives his book debts to the financial institution or bank with a discount.
Bill discounting includes parties like payee, drawee, and drawer whereas factoring involves client, debtor, and factor.
Bill discounting or invoice discounting and factoring both help entrepreneurs to use short term credit. When a businessman takes a decision for factoring or account receivable financing, he needs to sell the account receivables or due invoices to factor.
Comparison Table Between Bill Discounting and Factoring
| Parameter of Comparison | Bill Discounting | Factoring |
|---|---|---|
| Definition | Bill discounting is when one delivers the bill before the deadline at a cost which is less than the actual price. | Factoring is when a firm sells its book debt to the financial transaction of the factoring company at a discount rate. |
| Portion | Trade debts carrying the portion of the account’s receivables. | The entire portion of the trade debts of the company. |
| Affect | Advance payment by the customer for the issued bill. | The full purchase of the trade debts. |
| Type | In the case of Bill discounting method, only the option of recourse is available in this case | Both recourse and non-recourse options are available if the firm decides to go for factoring its entire portion of the trade debts. |
| Law and legislation under which the category falls | Bill discounting process falls under the Negotiable Instrument Act, 1881. | There is no Law and legislation act under which the method of factoring is susceptible to. |
What is Bill Discounting?
To put it simply the term
bill discounting means the fee required by the bank from the seller if he is
willing to sell the credit bills before the deadline of credit period arrives.
We will find the bill discounting method used frequently where the letter of credit takes place (also commonly written as L/C among the people involved in this arena). L/C has become mandatory for importing and exporting these days.
As the buyer or seller
from one country cannot see the seller or buyer from another country. Usually,
a credit window of 1 month, 2 months, 4 months are arranged by the seller for
the buyers.
The term “Discounting of invoice” is also used for the same purpose of bill discounting. How much creditworthiness a buyer has to play a big role to determine the amount of discount.
The amount of discount to be paid is decided by the bank based on the creditworthiness of the buyer. The 3 stakeholders in the process are payee, drawer and drawee.
What is Factoring?
Another type of financial
transaction is factoring. It is also a component of debtor finance in which the
seller of the goods sells his whole accounts receivables to a third party.
The major players in the
section are client, debtor, and factor. Both the options of nonrecourse and
recourse are available in it. Though there is no specific act proved by the law
for this method.
As the seller is
surrendering the whole receivables of the firm the payment of the financier is
considered in terms of the services provided by him for it for the completion
of the intended approach.
To meet its cash urgency which exists in the present time businesses often try the way of factoring. It enables the businesses to have cash in hand immediately though the amount is reduced than the actual accounts receivables.
Another term for
factoring is accounts receivables factoring as the selling of the receivables
plays a pivotal role in it. It should be kept in mind that factoring and
invoice do not mean the same thing in the United States.
In the accounting culture
of America Invoice discounting is commonly understood as assigning of accounts
receivables.
Main Differences Between Bill Discounting and Factoring
- In the case of Bill discounting Debt, an assignment is not available. But, in the case of Factoring Debt assignment can be exercised.
- In the event of bill factoring the Financier’s source of income is only subject to Charges of discounting or in other terms the interest associated with it. But when it comes to factoring, the financier is entitled to receive remuneration for the financial services and receives a commission for other associated services related to the event.
- In bill discounting, the assignment of debt option is not available. But in the event of factoring the firm holds the option of debt assignment in hand for its purpose.
- No certain rules are provided by the law for the factoring method. But in case of bill factoring Negotiable instrument act 1881 is mandated as a guideline for ending the process.
- Two major components for both the process is recourse and non-recourse. The first component recourse is entitled to bill factoring which means if the customer somehow fails to deliver the price of the goods in official term defaults to pay. And then the borrower of the money must pay the amount of money which the particular customer is not able to pay. In factoring both recourse and nonrecourse components come into existence. The term non-recourse means the borrower is not entitled to pay any money if one or more of his customers are in a position of not being able to pay. And the buyer of the accounts receivables takes full responsibility regarding the purchase and cannot make the borrower liable for anything short of his financial expectation.
Frequently Asked Questions (FAQ) About Bill Discounting and Factoring
Is factoring a loan?
Factoring is not a loan. In factoring, a company sells its outstanding invoice to a factor. The factor pays them a particular amount which could be 70%-80% of the amount raised in the invoice.
The rest of the amount is transferred to the company once the invoice is paid by the customers.
However, factors charge a fee of around 6-8%. Factoring is a method to get early access to money for the company’s present financial needs when the loan is not granted to it. It costs more than a loan but it is better than not having any money at all.
Is factoring invoices a good idea?
Factoring invoices has its own pros and cons. It lets you have early access to the cash that can be used to fulfill the financial requirements of the company at present. However, factors do charge a fee of 1-5%.
Early access to money does come with a little loss so you have to make sure that you can bear the loss or not.
Is Bill Discounting a loan?
Bill discounting is a type of loan given by the banks to a borrower. In bill discounting, the bank takes the bill of a company or borrower and pays them at the same time.
Later, the bank collects the amount from the borrower’s customer by submitting the bill to them. However, the bank does deduct some amount on the bill while paying the borrower.
What are the different types of factoring?
There are many types of factoring.
Here is a list of the main factoring types:
- Recourse factoring
- Advance factoring
- Bulk factoring
- Bank Participation factoring
- Invoice discounting
- Full factoring
- Agency factoring
- Domestic factoring
- Direct export factoring
- Direct import exporting
- Back to back factoring
- Maturity factoring
Is factoring short or long term?
Factoring is a short term solution for businesses that require early access to cash for fund growth or other financial needs.
Most companies stop factoring after 2 years of incorporation. Due to the discount given to factors, a company cannot rely on factoring for the long-term as it would result in more loss than profit.
Conclusion
The main concepts of bill or invoice discounting and factoring are quite the same. Both of them are methods of invoice finance.
The common order about which process is best comes down to how effective the credit collection, accounts, and book debt organization is.
Usually, those who have large and established businesses or those collections department choose to go for invoice discounting and those who don’t prefer for factoring.
References
- https://journals.sagepub.com/doi/abs/10.1177/0256090919880304
- https://link.springer.com/chapter/10.1007/978-1-349-12613-2_10