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 completely control 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 collect the due amount from his commercial partners, making repayment of his financed loan easier.
Key Takeaways
- Bill discounting is a short-term financing method where a seller of goods or services receives payment from a financial institution at a discounted rate in exchange for the buyer’s promissory note.
- Factoring is a financing method where a business sells its accounts receivable to a third party (factor) at a discounted rate in exchange for immediate cash.
- Bill discounting involves the sale of a single invoice, while factoring consists of multiple invoices.
Bill Discounting vs Factoring
The difference between Bill Discounting and Factoring is that 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.
Want to save this article for later? Click the heart in the bottom right corner to save to your own articles box!
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 use short-term credit. When a businessman decides on factoring or account receivable financing, he needs to sell the account receivables or due invoices to factor.
Comparison Table
| Parameter of Comparison | Bill Discounting | Factoring |
|---|---|---|
| Definition | Bill discounting is when one delivers the bill before the deadline at a cost 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 carry 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 the Bill discounting method, only the option of recourse is available. | Both recourse and non-recourse options are available if the firm decides to go for factoring in its entire portion of the trade debts. |
| Law and legislation under which the category falls | The Bill discounting process falls under the Negotiable Instrument Act of 1881. | No Law and legislation act under which the factoring method is susceptible. |
What is Bill Discounting?
Simply put, 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 the credit period arrives.
We will find the bill discounting method frequently used 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 as the buyer or seller from one country cannot see the seller or buyer from another country.
Usually, the seller arranges a credit window of 1 month, 2 months, or 4 months for the buyers. “Discounting of invoice” is also used for the same purpose as bill discounting.
A buyer’s creditworthiness plays a significant role in determining the discount amount.
The bank decides the amount of discount to be paid based on the buyer’s creditworthiness. The 3 stakeholders in the process are the 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 the 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. 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 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 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.
- The law provides no specific rules for the factoring method. But in the case of bill factoring Negotiable instrument act 1881 is mandated as a guideline for ending the process.
- Two major components for both processes are 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 terms 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 unable 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.
- https://journals.sagepub.com/doi/abs/10.1177/0256090919880304
- https://link.springer.com/chapter/10.1007/978-1-349-12613-2_10
I’ve put so much effort writing this blog post to provide value to you. It’ll be very helpful for me, if you consider sharing it on social media or with your friends/family. SHARING IS ♥️
Chara Yadav holds MBA in Finance. Her goal is to simplify finance-related topics. She has worked in finance for about 25 years. She has held multiple finance and banking classes for business schools and communities. Read more at her bio page.
