As an instrument in writing, a Bill of Exchange depicts the amount of money owed by the buyer of goods to the seller of goods. The debtor or buyer of goods signs the unconditional order prepared by the seller or creditor for a fixed amount of money payable on a particular (maturity or due) date. The sellers or creditors can use a bill of exchange just like any other current asset. As such, Bill of Exchange helps businesses meet financial needs by converting current assets into liquid assets.
There are a number of financial institutions – Banks, Non-Banking Financial Companies (NBFC) and Fintech Companies – that allow business owners to avail funds by discounting the bill of exchange before it is due for payment. Some lending institutions even allow entrepreneurs to avail funds by discounting unpaid invoices and goods received notes. But they pay the present value of the bill to the business owners after deducting their commission.
The financial institutions receive payment from the buyer or debtor once the bill or invoice is due for payment. Once can discount a bill or invoice with any bank or NBFC providing facilities like discounting bill of exchange. But the lending institutions lay down certain criteria to discount the bill or invoice. Following steps provide key steps before one considers discounting bill of exchange.
How to Discount Bill of Exchange in 5 Simple Steps
Pick the Lending Institutions
Most lending institutions these days provide bill or invoice discounting facility in addition to a myriad of business loan products offering additional funding choice for businesses to meet financial needs by converting a future dated bill or invoice into cash. Lending institutions can be shortlisted based on a number of important factors – credit limit, credit period, rate of interest, and disbursement process. Factors like processing timeline and ability to disburse funds quickly to the borrower should be considered while opting for a lending institution. Also, institutions which are flexible in their approach should be preferred over ones with strict credit requirements.
Understand Eligibility Criteria
Each lending institution will require the borrower to meet a set of eligibility criteria to avail bill or invoice discounting facility. For instance, some financial institutions provide credit for a period ranging from 10 to 100 days, whilst others require a high personal credit score. Also, the amount offered (or the discount percentage) also differ between various institutions. Hence, one needs to check if he is meeting the eligibility criteria set by the lending institution to discount a bill or invoice.
Compare Rates of Commission/Interest
In bill discounting , the lending institution will pay the present value of the bill or invoice. It will determine the present value of the bill by deducting commission or interest from original value of financial instrument. The rate of commission and interest charged by individual financial institutions differs. The rate of interest/commission and percentage of factoring must be kept in mind to reduce overall cost of financing.
Prepare the Required Documents
In addition to meeting the eligibility criteria, one also needs to provide the required documentation to avail bill discounting service. However, the documentation required by individual lending institutions differs. Most lending institutions require you to submit KYC documents. Some even require business owners to submit bank statements, audited financial statements, and GST registration certificate. One must read the information posted on the financial institution’s website or as provided to the borrower by the sales person of the institution to understand the documents required to avail bill or invoice discounting service.
Make the Required Arrangement
When an invoice is discounted, the lending institution receives payment from the buyer or seller when the financial instrument matures. But some lending institutions require additional arrangements like escrow accounts. You may have to make escrow account arrangements involving lending institution and buyer to ensure that buyer transfers all payment to the escrow account. However, the special arrangements differ from one lending institution to another.
On the whole, a borrower has option to choose from several financial institutions providing bill discounting or invoice discounting. But he must remember that the eligibility criteria for discounting bill of exchange differ from one lending institution to another. Also, the percentage of commission charged by individual financial institutions differs. Hence, it becomes essential to do some initial research to understand the right way to discount bill of exchange.