No entrepreneur can carry of day-to-day business activities smoothly without funding working capital needs on time. A business owner can fund working capital needs through an array of business loan products – overdraft, line of credit, term loan, soft loan and bank guarantee. But the smarter entrepreneurs explore ways to fund working capital needs without incurring debt and impacting cash flow.
Many entrepreneurs ask us what is Bill Discounting. Unlike conventional business loans, bill discounting or invoice discounting enables business owners to avail funds without increasing short-term or long-term liabilities. Many banks and non-banking financial companies (NBFCs) provide advance to customers by purchasing their bills of exchange or promissory notes. Likewise, many lending institutions help business owners to avail funds quickly by discounting their unpaid invoices or goods received notes.
When a business owner discounts his bills or invoices, the lender provides fund after deducting the discount charge. Hence, it becomes easier for entrepreneurs to avail funds before the due date of the bills/invoices. Many entrepreneurs nowadays prefer bill/invoice discounting to other working capital loans. However, the entrepreneurs must keep in the mind bill discounting advantages and disadvantage to decide the most appropriate working capital financing solution.
Bill Discounting Advantages and Disadvantages
Important Advantages of Bill/Invoice Discounting
No Need to Incur Debt
As noted earlier, bill or invoice discounting enables business owners to fund working capital needs without increasing liabilities. The business owner can opt for this option to avail cash quickly by releasing the funds locked in unpaid invoices or bills. He can even meet working capital needs simply by converting current assets into liquid assets.
Improve Cash Flow Position
Often small businesses have to sell goods in credit to expand customer base. When they sell goods on credit, it becomes difficult for entrepreneurs to maintain positive cash flow. The invoice discounting services provided by lending institutions help entrepreneurs to improve cash flow quickly. They can even shorten the working capital cycles by converting unpaid invoices into cash.
Help Businesses to Sell Goods on Credit
Many enterprises explore ways to credit sales to maintain a positive cash flow position. But small businesses cannot acquire new customers and retain existing customers in the long run without combining cash and credit sales. The bill discounting services make it easier for enterprises to sell goods in credit by liquidating current assets and boosting cash flow.
Access Funds Quickly
No entrepreneur can avail conventional working capital loans without meeting the eligibility criteria set by the lending institutions. Many lending institutions even require additional time to process and disburse small business loans. Hence, many business owners opt for bill discounting to avail funds without lengthy approval process. A number of NBFCs even enables borrowers to avail cash in 72 hours by discounting their unpaid invoices.
Bill Discounting Disadvantages
Reduces Profit Margin
The lending institutions discount bills or invoices by charging a fee. The fee normally includes interest charges, administrative expenses and maintenance expenses. The percentage of fee or discount also differs from one lender to another. Hence, the business owners have to sacrifice a percentage of the bill value. The fees charges by the lender will even impact the business’s profitability.
All Bills Cannot Be Discounted
An entrepreneur cannot avail funds by discounting all his unpaid bills or invoices. Many lending institutions discount only commercial bill. Also, they evaluate the bills or invoices based on a number of parameters before providing funds. Hence, entrepreneur cannot rely on bill discounting as a consistent or long-term working capital funding solution.
Not Available to New Businesses
Both banks and NBFCs provide bill discounting services only to existing customers or established enterprises. Some lending institutions even provide discount bills only if the business is generating profit. Hence, new business owners may not fund working capital needs through bill discounting service. Also, the fees charged by the lending institutions will impact their profitability in the short run.
Reduce Available Collateral
Most banks do not provide collateral free business loans to small business owners. They require the borrowers to use their personal and business assets as collateral to avail credit. Each time a business owner discounts an invoice or bill, his working capital declines accordingly. Hence, the business owner may find it challenging to avail other working capital loans.
On the whole, bill or invoice discounting help business owners to fund working capital needs without increasing liabilities. They can avail the invoice discounting services provided by various lending institutions to avail funds before the due date of the bill or invoice. However, the percentage of discount changed by individual lenders differs. Likewise, the lenders require the business owners to meet a set of eligibility criteria to avail bill discounting services.