Steady cash flow is critical to keep operations of any business enterprise running smoothly and for its overall growth. Unsettled bills can, however, often hinder the regularity in receiving cash or fund. You can thus leverage the unpaid invoices in your books to secure funds immediately via bill financing.
It’s a broad term with two primary subsets, bill discounting and bill purchase or factoring. Understanding the difference between them is crucial to ensure that you seek the one most suitable for your business requirements. Take a look!
Bill Discounting Vs Bill Purchase: Definition
In a bill discounting facility, a business leverages its invoices with a third-party – generally, a financial institution – to avail cash advance at a discounted rate.
For example, your books carry trade receivables worth Rs. 1 lakh. You provide the corresponding invoices to a financial institution, and it agrees to advance 95% of the book value, i.e. Rs. 95,000, as a loan.
Also, your customers or debtors would not know that the receivables are leveraged to avail credit. Thus, you retain credit control and a responsibility to collect payments from your customers/debtors.
Bill purchase or invoice factoring involves a similar financing process virtually. The business sells its in-arrear bills to a financial institution, called the factor, which provides cash advance at a discounted rate against such invoice value.
Under invoice factoring, though, the factor assumes credit control and the responsibility to recover payments from your customers/debtors. Thus, in this case, your business debtors are aware that you’ve leveraged their invoices with a third-party to raise funds.
This is the primary difference between bill purchase and bill discounting. In one case, you retain the credit control, in another, the factor assumes it.
How Do They Work: Bill Discounting vs Bill Purchase?
1. Invoice Discounting
- Your business prepares invoices against the credit sale of goods or services.
- You share the invoice details and corresponding bills with your lender.
- This institution assesses the invoices and provides cash advance at a discounted rate against their value.
- Your business’s credit controller then sets to collect payments from the debtors.
- When the invoices are settled, you repay the lender such a loan amount.
The cash advance you receive via the bill discounting facility does not involve any spending constraints. Thus, you can channel this fund for any purpose, like paying suppliers, undertaking a new venture, etc.
2. Bill Purchase
- Invoice is generated against the sale of goods and services on credit.
- You sell the bills to the factor.
- This financial institution analyses the invoices and provides a percentage, let’s say 80% of their value as a cash advance.
- Such a lender then initiates the payment collection process.
- When your customers or debtors clear up payment, the factor forwards you the remaining 20% of the invoice value, minus the service fee or interest.
Similar to bill discounting, there’s no end-use restriction involved with the invoice factoring facility.
Pros And Cons Of Bill Discounting And Purchase
Some common advantages of both these financing options are:
- They provide access to instant financing without any collateral.
- Businesses can streamline their cash flow with ease and efficiency, especially if credit terms vary across clients.
- They do not encumber the finances of a business.
Apart from this, when considering whether to go with bill discounting or purchase, take a look at the following points
1. Customer Relationship
With bill discounting, you undertake the responsibility of outstanding payment collection from your customers. Since it is confidential, your customer relationship remains unaffected.
In the case of bill factoring, the lender collects the outstanding payment. Thus, your customer relationship may be affected.
2. Payment Collection
Your business may benefit from the expertise of a lending institution in terms of payment collection, but that may not always be the case. Thus, you may opt to go with bill purchases if you think their payment collection process can be more effective than otherwise.
On the other hand, you might choose to stick with bill discounting if you wish to retain the responsibility to collect payments from debtors.
Now that you are aware of the points of difference between bill purchase and bill discounting and its implication on your business, it’ll be easier to decide which invoice financing option will maximise your benefits.