How does bill discounting work and is it helpful?

A business can raise precious working capital against its unpaid bills by means of bill discounting. We explain how it works.

Whether big or small, every business requires daily working capital. Each company has daily and monthly overheads – from buying new office stationery to paying rent and staff salaries. A steady inflow of revenue is key to being able to pay these overheads and also maintain petty cash for daily expenses. However, many companies make the mistake of depending only on the business’ income.

Businesses can raise essential working capital by the simple expedient of bill discounting. This is a process whereby the business gets funds from a lending institution against unpaid bills that will be settled shortly.

How bill discounting works

Under invoice discounting, a company borrows funds for a short period of time against unpaid bills raised to other businesses and vendors. These bills are not yet paid or settled in any part, but have been presented for scrutiny to accounts. The company can then raise a percentage of the bills’ total value in lieu of working capital. The bills are kept as collateral or guarantee with the lending institution.

The process of bill discounting involves three parties – the company, the vendors and/or businesses that will settle the bills and the lending institution. The lender is known as the ‘buyer’ and is normally a bank or a financial institution.

Why bill discounting

The process helps raise funds in a short period of time, for a short period of time. Your business gets essential cash without having to wait for bills to be settled, and without relinquishing control over credit. This is a significant departure from ‘factoring’, where credit control rests with the buyer.

Also, invoice/bill discounting takes place in an environment of utmost discretion, so that the market does not hear of the business borrowing money against bills – an important consideration if the business is in the process of pitching for funding to VC firms and angel investors.

However, the idea behind approaching a buyer for bill discounting is to get working capital to put operational plans underway. The company can confidently pitch for new business and enhance its ties with existing customers – since its cash reserves are not depleted, it can take many new decisions to upscale operations and get new business.

More importantly, its current worries about raising enough capital to pay for daily and monthly expenses are laid to rest with bill discounting.