Factoring vs Bill Discounting
As both factoring and bill discounting are sources of short term finance which are offered by banks and financial institutions, knowing the difference between factoring and bill discounting is nothing but helpful. Factoring and bill discounting offer sellers and traders the facility to collect their receivables faster without having to have capital tied up. Since the use of factoring and bill discounting help to improve cash flow, these sources of short-term finance are quite popular among traders and are used greatly in international trade. Despite their similarities, there are a number of subtle differences between factoring and bill discounting. The article that follows offers a clear explanation on each and highlights their similarities and differences.
What is Factoring?
In factoring receivables, the trader sells their unpaid invoices to factoring companies such as banks and financial institutions at a discounted rate. Then these factoring companies immediately pay the trader the value of their invoices minus a fee. This is very convenient to the seller as he is not only able to recover his receivables faster , but factoring also improves cash flow by releasing funds which would be tied up for an indefinite period. In the process of factoring receivables, factoring companies are also responsible for maintaining all credit control activities including management of the sales ledger and collecting debts directly by contacting customers. Recourse factoring is beneficial to factoring companies, as in the event that the customers do not pay their bill amount to the factor within 60 to 120 days the trader is required to buy back those invoices and has to suffer the loss of non-payment. In non-recourse factoring, the risk and loss of non-payment are borne completely by the factoring company. Freight factoring services are also used to receive payment on freight bills. The freight handling firm can sell their bill of lading or freight bill to the factoring company and receive cash immediately.
What is Bill Discounting?
In bill discounting, the seller of goods draws up a bill of exchange on the buyer of the goods and then discounts the said bill of exchange with a bank or financial company. The seller is able to get immediate finance minus the fee charged by the finance firm. Bill discounting lets the seller recover their receivables faster thereby improving cash flow. Before purchasing the bill, the bank or financial institution has to consider a number of factors including the risk of non-payment associated with the bill and the amount of time remaining for the bill to become due. A bill with lower risk and shorter duration of becoming due is preferred. Once the buyer of the goods makes the payment to the bank the transaction is settled.
What is the difference between Factoring and Bill Discounting?
Factoring and bill discounting are both sources of short term finance which offer traders and sellers an avenue to obtain payment for receivables in a fast and convenient manner. Both forms of short term financing help improve cash flow and working capital management. Despite their similarities, there are a few differences between factoring and bill discounting. Bill discounting is always recourse, whereas factoring may be recourse or non-recourse. Factoring also maintains sales ledgers and collect debt, while bill discounting only involves the purchase of the bill and no sales ledger maintenance is carried out by the finance company. It is possible for a bill to be discounted a number of times before maturity. However, this is not the case for factoring. Factoring is a facility that can be extended over a number of invoices, whereas in bill discounting each bill is assessed individually before being discounted.
Summary:
Factoring vs Bill Discounting
• Factoring and bill discounting are both sources of short term finance which are offered by banks and financial institutions.
• In factoring receivables, the trader sells their unpaid invoices to factoring companies such as banks and financial institutions at a discounted rate.
• In the process of factoring receivables, factoring companies are also responsible for maintaining all credit control activities including management of the sales ledger and collecting debts directly by contacting customers.
• In bill discounting, the seller of goods draws up a bill of exchange on the buyer of the goods and then discounts the said bill of exchange with a bank or financial company.
• Before purchasing the bill, the bank or financial institution has to consider a number of factors including the risk of nonpayment associated with the bill and the amount of time remaining for the bill to become due.
• Factoring is a facility that can be extended over a number of invoices, whereas in bill discounting each bill is assessed individually before being discounted.
Further Reading:
- Difference Between Factoring and Accounts Receivable Financing
- Difference Between Factoring and Forfeiting
- Difference Between Factoring and Invoice Discounting