Factoring V/s Bill Discounting in Receivable Management

05/12/2021 0 By indiafreenotes

Factoring is a transaction in which the client or borrower sells its book debts to the factor (financial institution) at a discount. Having purchased the receivables the factor finances, money to them after deducting the following:

  • An appropriate margin (reserve)
  • Interest charges for the financial services
  • Commission charges for the supplementary services.

Bill Discounting

Bill Discounting is a process of trading or selling the bill of exchange to the bank or financial institution before it gets matured, at a price which is less than its par value. The discount on the bill of exchange will be based on the remaining time for its maturity and the risk involved in it.

First of all, the bank satisfies himself regarding the credibility of the drawer, before advancing money. Having satisfied with the creditworthiness of the drawer, the bank will grant money after deducting the discounting charges or interest. When the bank purchases the bill for the customer, it becomes the owner of the respective bills. If the customer delays the payment, then he has to pay interest as per prescribed rates.

Further, if the customer defaults payment of the bills, then the borrower shall be liable for the same as well as the bank can exercise pawnee’s rights over the goods supplied to the customer by the borrower.

Differences

Control of Sales Ledger

In factoring, the bank giving credit takes the onus of checking on the sales ledger, control of credit and chasing your clients for paying back. The work of collection and follow up is outsourced to the bank. Whereas bill discounting requires your own accounts team to take care of the sales invoice, follow-ups and the money is paid directly to you.

Size of the Business

Factoring is useful for larger businesses where an entire line-up of client credits have to be managed. Bill discounting might be useful for small businesses where you do not want your clients to deal with your bank/ third party intermediary and give them an impression of your cash flow situations. Also, bills might not be available on a continual basis for discounting.

Client Interaction

In factoring the client settles their payables with the factor (such as a bank). In bill discounting, the client will not really know the involvement of a third party. The transaction happens between banks where the confirming bank or the buyers’ bank does not intimate the seller of the reimbursement instruction but deals with his bank directly to determine the discounting terms.

Company Involvement

Taking factor services allows you to focus on your business and the factor who is an expert in this field can provide a line of credit to you along with collection services. Bill Discounting requires your team to be involved in the entire process of recovery.

Amount Received by the Company

The drawer company (which is the seller) receives the amount minus a small discount immediately in a bill discounting. Factor companies can release the money within 24 hours to the seller and he can get instant liquidity to continue operations. Here the chunk of the invoice face value is paid to the seller called as “Advance Rate”. The remaining of the face value of invoice can be paid once the buyer’s payment is received by the seller’s bank.

Compensation to Bank/Financier

The bank receives discounting charges for the credit and in factoring it charges commission along with interest.

Recourse

Factoring is only under recourse i.e if the customer fails to pay to the financier, the credit has to be paid by the seller. In bill discounting, there are two methods to present the bills to the buyer’s bank with recourse and without recourse.

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.
Law and legislation 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.
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.
Financier’s Income Discounting Charges or interest Financier gets interest for financial services and commission for other allied services.
Assignment of Debts No Yes