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Bill discounting vs Factoring

Bill discounting vs Factoring

Bill Discounting and Factoring both are short-term finance availing which the financial requirements of a business can be fulfilled quickly. Factoring is related to borrowing funds from the commercial bank while bill discounting is related with the management of book debts.

The term factoring consists of entire trade debts of a customer. On the other hand, bill discounting orients around trade debts that are supported by account receivables. Overall, we can say bill discounting, implies the advance against the invoice or bill, whereas factoring implies over the outright purchase of trade debt.

What is bill discounting?

Bill Discounting can be considered as a process of selling the bill to the third party which can be a bank or financial institution before its date of maturity, at an amount which will be less than its par value. The discount given against the bill is based on the remaining maturity time as well as the risk involved in it.

First of all the third party satisfies their firm regarding the drawer’s credibility, before advancing them with money. After knowing with the creditworthiness of the drawer, the financial institution will grant fund after deducting the relevant discounting charges or interest. When the financial institution purchases the bill for the client, it becomes the owner of the respective bills. If the client delays the payment, then he is supposed to pay interest as per prescribed rates.

What is factoring?

Factoring is a transaction process in which the customer or borrower sells its book debts to the financial institution called factor at some particular discount. Having purchased receivables the financial institution finances, money to them after the deduction of the following:

  • An appropriate margin
  • Interest charges for the financial services being provided
  • Commission charges for the supplementary services

Now, the customer forwards the collection of payment from its buyer to the financial institution or the customer may ask to forward the payment to the financial institution or to the factor to settle the balance dues. The factor provides the following services to the customer: Credit investigation along with debtors ledger maintenance, collection of debts from the buyer, credit reports on debtors and so on.

Key differences

The following are the major differences between bill discounting and factoring:

  • Bill discounting means to sell bills at a discount to the bank, before its maturity whereas selling of the debtors to a financial institution at a discount is termed as factoring.
  • The bill is discounted, and the generated amount is paid to the client i.e. borrower at the time of the transaction. Conversely, in factoring the client is provided with maximum part of the amount an advance, and the rest amount is given in terms of balance when the dues are realized.
  • The parties involved in bill discounting are termed as a drawer, drawee, and payee whereas the parties involved in factoring are the factor, debtor, and borrower.
  • The bill discounting is recourse in nature, which means if the buyer defaults in payment of debt, then the payment has to be made by the borrower. On the other hand, in the case of factoring you have option to choose recourse and nonrecourse.
  • The Negotiable Instrument Act, 1881 contains the rules that relate to bill discounting whereas, the factoring is not covered under any act.
  • In bill discounting the provider gets the discounting charges for financial services being provided, but in the case of factoring the factor gets interest along with its commission.
  • The debts are assigned in factoring which is not done in bill discounting.

Comparison chart

Bill discounting Factoring
Control of sales ledger has to be taken by the business Control of sales ledger is taken by factor
Suitable for small businesses Suitable for large businesses
No assignment of debit Assignment of debit
Bill is discounted and paid when the transaction takes place Maximum amount is paid in advance and the rest is paid at the time of settlement
Always recourse in nature Can be recourse or non-recourse
Falls under negotiable instrument act, 1881 There is no specific law for factoring
Parties involved: drawer, drawee, payee Parties involved: factor, debtor, customer
Financier charges fees in the form of discounting charges or interest Factor charges fees in the form of interest and commission for the services

Conclusion

In bill discounting, bills are used for transactions while in the case of factoring accounts receivable are sold to the factor. You should choose them as per the business needs and your own capabilities. In bill discounting the service of financing is provided by the bank whereas in factoring additional services are provided by the financier on interest rate and commission.