Bills discounting and factoring are two financial instruments used by businesses to improve their cash flow. Here are the key differences between bills discounting and factoring:
- Definition:
Bills discounting is a process in which a seller (borrower) of goods or services draws a bill of exchange on the buyer (debtor) and sells it to a bank or financial institution at a discount. Factoring is a financial service in which a business sells its accounts receivable (invoices) to a factor (a financial institution or a third party) at a discount in exchange for immediate cash.
- Nature of transaction:
Bills discounting is a short-term financing arrangement that helps the seller to obtain immediate cash by selling the bill of exchange to a bank or financial institution at a discounted price. Factoring, on the other hand, is a long-term financing arrangement that provides a business with working capital by selling its accounts receivable at a discount.
- Risk involved:
In bills discounting, the risk of non-payment of the bill of exchange falls on the seller (borrower), and the bank or financial institution assumes no responsibility for the payment. In contrast, in factoring, the factor assumes the credit risk associated with the accounts receivable.
- Control:
In bills discounting, the seller (borrower) retains control over the collection of the payment from the buyer (debtor) and is responsible for the collection process. In factoring, the factor takes over the collection process of the accounts receivable, and the seller (borrower) loses control over the collection process.
- Cost:
In bills discounting, the cost of financing is lower compared to factoring as the risk associated with the transaction is lower. In factoring, the cost of financing is higher as the factor assumes the credit risk and provides additional services such as credit checking, collection, and administration of the accounts receivable.
- Usage:
Bills discounting is typically used by businesses that have a short-term need for cash, whereas factoring is used by businesses that require a long-term source of working capital.
In summary, bills discounting and factoring are two different financial instruments that serve different purposes. Bills discounting is a short-term financing arrangement that provides immediate cash to a seller by selling the bill of exchange at a discounted price. Factoring, on the other hand, is a long-term financing arrangement that provides working capital to a business by selling its accounts receivable at a discount.