What is Bill Discounting and Factoring? Briefly explained with an example

By | November 27, 2019

Bill discounting and factoring is related to bills or invoice of a seller and a buyer when buyer purchase goods on credit from the seller. These are also known as Invoice discounting vs factoring. Bill discounting facility is available in many countries. Let’s discuss Bill discounting vs factoring

Bill Discounting

First of all, we will see what is Bill discounting?

Bill discounting is an agreement between a seller and Bank on the invoice or bill that the seller has drawn to the buyer. We try to understand by a simple example;

Bill discounting and factoring

Example:

Suppose a buyer purchase goods from the seller on credit and seller draw a bill of $ 10,000 on 90 days of the credit time period. It means the buyer will pay the amount of $10,000 of goods that he has purchased from the seller after 90 days. The seller will draw a bill or invoice to the buyer. Here Seller is Drawer and the buyer is Drawee.

So, the seller has raised a bill or invoice to the buyer of goods that he has purchased. The bill amount is $ 10,000 and the time period is 90 days.

Suppose the seller needs money after 60 days for somewhat reasons. But according to the invoice or bill, he can’t ask the buyer to pay its amount now because he made an agreement of 90 days. So, what will he do?

He will go to the Bank and show that invoice or bill to the bank and ask for money, the bank will deduct 30 days interest on that money ($ 10,000) and give the remaining amount to the seller. Now the bill or invoice is the bank’s property, Bank will receive money from the buyer after 30 days because the seller came to the bank after 60 days. Now the buyer will pay money of $ 10,000 to the bank instead of the seller. If the buyer defaults the seller will be responsible for this issue.

Bill Amount = $ 10,000   ( Buyer will pay this amount after Days 90 )

( After 60 Days when seller came to Bank)

The interest of 30 days that Bank charged = $ 1000

Remaining Amount that Seller received from Bank = $9000 ( After 60 days)

The Amount that Bank will receive from Buyer = $ 10,000  (After 30 days)

What is Factoring?

Factoring is selling of bills. In this scenario, the seller gives goods to the buyer on credit and raise a bill or invoice. The seller sells its all bills to a factoring body which can a financial institution. When the seller sells bills to the financial institution then in this case seller has no account receivable because he sells bills and collects money from the financial institution.

Cons/Disadvantage of Factoring

Factoring is expansive than bill discounting. Factoring institute deducts interest and other service charges and gives the remaining money to the seller.

Suppose the worth or amount of all the bills that seller sells to factoring institute is $ 10,000. Factoring institute will deduct interest $1000 and other charges suppose $500 the remaining amount will be $8500 that seller will receive.

Pros/Advantage of Factoring

The biggest advantage of factoring is you can receive your money immediately. Seller doesn’t need to wait for its account receivables. The seller can save its time by doing factoring of bills.

Types of Factoring

There are two types of factoring

With Recourse:

In this factoring, if the bill that the seller has given to default, factoring institute will go seller and seller will deal it. In short, the seller will be responsible for any default about its bills that he had sold to the factoring body.

  • Seller is Responsible
  • Not risky for Factoring Institute/Body

Without Recourse:

In this type of factoring, If any bill default, factoring institute is responsible. It is risky and the factoring body already charges more money from the seller in case of these risks.

  • Seller is not Responsible
  • It is risky and factoring Institute already charged for these types of bills

Read More

Introduction to e-Banking – List of eBanking services

Financial Statements of Banks – Reviewed financial statement- Financial statement analysis of banks