Bill Discounting, Factoring and Forfeiting

Bill Discounting

While discounting a bill, the Bank purchases the bill receivable to the Exporter (i.e. bill of exchange or Promissory Note) before its due date and credits the value of the bill to the exporter’s account after deducting a discount. The transaction is practically an advance against the security of the bill and the discount represents the interest charged on the advance given, which is payable from the date of purchase of the bill until it is due for payment.

How it works:

• The Exporter and the exporter’s bank first enter into an agreement which outlines the terms and conditions for availing the facility of Bill Discounting.
• The Exporter then submits the documents to his bank, which will be sent to the importer's bank for acceptance.
• The Importer's bank then sends a notification to the Exporter’s bank intimating it once the bill has been accepted.
• Upon receipt of the accepted bill the Exporter then applies to his bank to discount the bill.
• Once the application is received the bank then processes the application and sanctions the amount deducting a portion of the face value of the bill as a discount. The Discount amount depends upon the period of time left until the due date of the bill.
• The Importer on the due date then makes the payment to the exporter’s bank, which will be used to offset the advance given in lieu of the bill receivable.

Benefits:- 

• Discounting of bills provides the exporter with a short-term source of finance to fund his working capital needs.
• Bills discounting being categorized as a transaction, falls outside the ambit of Section 370 of the Indian companies Act 1956, which places a restraint on the quantum of loans that can be given by group companies.
• Since it is a form of lending, no tax at source is deducted while making the payment; this makes it very convenient to the exporter not only from the cash flow point of view, but also from the perspective of companies that do not factor in tax costs.
• The rates of discount charged while discounting a bill are lower than those charged while availing ICDs (Inter Corporate Deposits).
• Bill discounting provides the exporter flexibility not only on the quantum of funds, but also on the duration.

Factoring:

Factoring is a service which involves the purchase of trade receivables which a customer owes to a manufacturer or distributor by a financial organization, called a factor, with the factor assuming the entire responsibility of credit and collection.

It is a process wherein the Factor pays the exporter in advance against the credit invoices that the exporter regularly raises on his established clients. In settlement of this obligation, the importer pays the Factor on the respective due dates directly

How it works:

The exporter has to first deliver the goods or services to his client and raise an invoice against the importer.

On an on-going basis, all the invoices which have been raised against a pre-agreed buyer, along with supporting trade documents are then assigned to the factor.

The Factor then provides the exporter with an advance (upto 80%), in some cases as early as the next business day upon receipt of such documents (subject to the documents being in order).

On payment of the respective invoice by the importer to the Factor, the balance amount (if any) is then credited to the exporter's account.

Benefits:

• The exporter gains from predictable cash flows which are linked directly to his performed sales.
• The exporter can easily convert credit receivables to cash, as the Factor will normally provide a pre- payment immediately upon receipt of documents.
• The funding normally happens in a short duration from the receipt of documents, this enables the exporter to plan and manage his cash flow more effectively.
• The Factor can also provide the exporter with a credit assessment of customers both new and existing.
• Factoring companies also tend to provide additional services such as accounts receivable, reporting, sales ledger administration and debtor follow-up.
• Factoring ensures that no additional debt is created on exporters balance sheet as it is an advance given to the exporter on behalf of an asset.
• The outsourcing of trade receivables collections processes can allow the exporter to focus on his core business activities.

Forfaiting:

Forfaiting is a form of service which involves the purchase of credit instruments such as availed bills of exchange, letters of credit, promissory note or other freely negotiable instrument from the exporter on a non-recourse basis i.e. the forfaiting company will not recover the amount from the exporter if the buyer defaults.Forfaiting is a form of service which involves the purchase of credit instruments such as availed bills of exchange, letters of credit, promissory note or other freely negotiable instrument from the exporter on a non-recourse basis i.e. the forfaiting company will not recover the amount from the exporter if the buyer defaults.

These transactions are normally supported by the buyer’s bank and hence the risk of payment default is primarily carried by the bank or financial institution. The forfeiter then deducts interest (in form of discount) and pays the balance to the exporter on a non- recourse basis.

How it works:

• The Exporter ships the goods or provides the service as per the terms of the contract and then submits the necessary documentation to the forfaiting company or the forfaiting company’s bankers.
• Trade documents are transmitted to the importer’s bank for acceptance and assignment of proceeds to the Forfaiting company.
• On receipt of such confirmation, the forfaiting company pays the discounted proceeds to the exporter on a non-recourse basis.
• The forfeiting company then assumes the risk of payment by the importer's bank.

Benefits:

• Forfaiting helps the exporter by providing 100% financing without any recourse to the seller.
• Forfaiting helps eliminate the risks associated with carrying out trade as the entire risk of default, currency and interest rates are transferred from the exporter to the forfeiting company.
• Forfaiting helps the exporter to improve his cash flows by providing liquidity against transactional documents.
• Forfaiting helps improve the exporter’s balance sheet as it removes accounts receivables, bank loans or any other contingent liabilities.