Bill discounting and bill purchase are often assumed to have the same meaning. This is a common misconception among business owners. Understanding the difference between the two is vital so as to ensure the option that suits your business better.
Understanding bill discounting
Bill discounting is a process that involves using unpaid invoices as collateral (usually banks or financial institutions) in exchange for a short-term loan at a value less than the total amount of the unpaid invoices. The business does not receive the entire amount since they offer the third party a discount on the same.
This is done mainly to ensure that the business has sufficient funds to meet its working capital needs. Steady cash flows are necessary for a business to maintain a healthy growth rate. Here, the collection responsibility and credit control shall remain with the business. Credit control here refers to the control/right of the business over the dues of the debtors.
Meaning of bill purchase
Bill purchase is also known as factoring. This is a process where the unpaid invoices are sold to a third party (also known as factors) in exchange for a discounted final settlement. Here, the credit-control and responsibility of collection of the dues is transferred to the factor. It is the responsibility of the factor to collect the dues from the customers or debtors.
For instance, ABC Ltd has Rs.3,00,000 as trade receivables and approaches XYZ Ltd, a factor, for sale of these receivables, since ABC Ltd has an immediate need for cash. XYZ Ltd buys the trade receivables from ABC Ltd for Rs.2,80,000 as the full and final settlement. The right to collect the dues and the responsibility of collection now lies with XYZ Ltd.
Comparison between bill discounting and bill purchase
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| Bill Discounting | Bill Purchase |
| The details of the unpaid invoices is shared with the lender | The unpaid invoices are sold to the factor |
| Invoice value is assessed after which a short term loan is given based on the value | The factor makes the payment of the invoices after deducting their fees |
| Credit control lies with the business | Credit control is shifted to the factor |
| The responsibility to collect payments lies with the business | The responsibility to collect the payments now lies with the factor |
| Customers are not made aware of the leveraging of invoices | Customers are made aware that the dues must now be paid to the factor |
Which of the two is superior for businesses to choose?
Bill discounting and bill purchase both offer the business a method of obtaining funds as they await the outstanding dues from customers. The purpose they serve is similar in nature. However, there are a couple of factors to consider to choose the best alternative:
In the case of bill discounting, the responsibility to collect the dues from the customers still lies with the business. The customers need not be informed of the act of bill discounting taken by the business. Therefore, the customer relationship remains unaffected. However, with bill purchase, the responsibility of collection is transferred to the lender (factor). Therefore, the potential of the customer relationship getting affected is quite likely.
Sometimes, the business may benefit from handing over the responsibility of collecting the dues to a lending institution. However, this differs on a case-to-case basis. If the business opts for bill purchase, this will be the case. On the other hand, if the business wishes to collect the dues on its own, bill discounting is the option that they should go for.
