Bill discounting is a financial instrument, which allows buyers to procure goods or services and sellers to raise capital against invoice bills. In international trade, it plays a crucial role and often many reputed buyers use this method to purchase goods or services from international sellers.
In this financial process, banks lend the seller capital in exchange for the invoice. However, the banks also charge fees for this process and the seller gets fewer amounts that were issued in the bill. Let’s learn how bill discounting works and what are the advantages and disadvantages of this financial instrument.
How does it work?
Most of the time when a business temporarily runs low on cash use the bill discounting method to pay its seller or supplier. For example, in a business transaction, a seller Jon sells $10,000 worth of goods to buyer Sam. But currently, Sam doesn’t have the money.
Fortunately, he will have the money in the next 2 months. So, Sam writes a bill in Jon’s favor that he can draw the money from him on a certain date after 2 months. Now, Jon needs capital for his regular business expenses. He can deposit the bill to a bank and raise capital against it. After two months, the bank will draw the money from Sam.
Banks do not do this task for free. All banks charge fees for procedure. In financial world many people call it Bill Discounting or Invoice Discounting. In the financial transaction process, the seller gets fewer amounts, which was mentioned in the bill. Banks take this amount as fees for facilitating the transaction. In this process, the maturity date of the invoice plays a crucial role. Banks charge extra for the extended bill maturity date. Many banks only offer this facility to reputed individuals and companies.
Advantages of Bill Discounting
Multiple advantages come with the bill discounting process. It allows the buyer to procure goods or services against bills or invoices. It also allows the seller to raise essential capital when needed and increase the capital flow to the business. On the other hand, banks also gain profit by facilitating this financial process.
This process gives the flexibility to the seller for doing business. The seller also doesn’t need to knock buyer’s door for payment. Instead, the bank takes care of this task. Overall this process strengthens the business relationship and makes complex trading possible with ease.
Disadvantages of Bill Discounting
Bill discounting is not a complete business solution and there are few disadvantages associated with it. Most banks offer bill discounting process to reputed business individuals and companies only. For this reason, small businesses cannot take benefit of this facility.
Banks also increase their charges with a prolonged bill maturity date, which can substantially reduce the billed amount. The bill or the invoice is a legal obligation, which the buyer has to pay at the given time. Failed to pay the amount on the given day can have serious consequences. In such cases, the bank can sue the buyer and take appropriate legal action against the buyer.