Bill discounting is the facility which is provided by the banks to its customers who do business, using this facility the businessman can discount his or her bills of exchange with banks and can receive the payment immediately which in turn results in immediate liquidity for the businessman. Bill discounting is also known as invoice discounting, in order to understand this concept better let’s look at some of the advantages and disadvantages of bill discounting –
Advantages of Bill Discounting
- The first and foremost advantage of bill discounting is that businessman get the cash immediately for day to day activities of the business and we all know that liquidity is to business is what water is for human body, just as without water a human cannot survive for long in the same way without liquidity a business cannot survive for long. For example if the company has sold goods and received $5000 bill of exchange from its creditors and if the customer chooses to bill discount facility then bank will immediately give the amount to the businessmen thereby giving instant liquidity to the businessman and hence that $5000 will not be locked and the businessman can use that fund.
- Another benefit of bill discounting as far as banks are concerned is that banks earn commission on the bills discounted and it leads to extra income for the banks and this type of income is less risky if one compares it with other types of finance or loan given by banks.
- As far as the businessman is concerned there is no need for collateral and hence the assets remain with the business only and there is no additional burden of mortgaging the asset with the bank as businessman receive funds in lieu of bills of exchange lying with him or her.
Disadvantages of Bill Discounting
- In the case of bill discounting bank discounts this bill upfront from the customers leading to extra cost as far as the businessman is concerned which in turn leads to fall in the profit margin of the businessman. For example if the bill is of $5000 and bank discount rate is 2 percent on bill discounting service than the company will receive only $4900 and this $100 is the charge which the company has to bear due to it opting for bill discounting.
- As far as banks are concerned it puts an additional burden on the bank as chances of creditors not honoring his or her bills are there and also banks have to bear additional administrative expenses related to bill discounting besides bank receive only small amount from doing this transactions.
- Another disadvantage of bill discounting is that businessman cannot depend on this type of finance as it is a short term source of finance and complete dependency on this type of finance can be disastrous for the business.
As one can see from the above that bill discounting has both advantages as well as disadvantages and it is up to the company whether it wants to go ahead with bill discounting or not as every company has different requirement and circumstances.