Bill Discounting

Bill discounting is a financial service offered by banks and financial institutions that allows a business to obtain short-term funds by selling its trade bills (bills of exchange) before their maturity date. It is a key instrument in working capital finance, enabling companies to manage liquidity by converting credit sales into immediate cash. Bill discounting thus serves as an essential link between trade credit and bank credit in commercial transactions.

Concept and Definition

When a seller sells goods on credit, a bill of exchange or trade bill is drawn on the buyer for the amount due, specifying a future payment date. The buyer accepts the bill, signifying the promise to pay the stated amount on maturity. The seller, rather than waiting until the due date, may present the bill to a bank for discounting.
The bank pays the seller the bill amount minus a discount (interest or commission for the period until maturity) and collects the full value from the buyer upon maturity. In essence, bill discounting involves the sale of a bill of exchange at a price less than its face value.
For example:If a trader holds a bill worth ₹1,00,000 due in 90 days, and the bank discounts it at 12% per annum, the trader receives:₹1,00,000 – (₹1,00,000 × 12% × 90/365) = ₹97,041 approximately.Here, ₹2,959 represents the discount or interest charged by the bank.

Parties Involved in Bill Discounting

1. Drawer: The seller who draws the bill of exchange.
2. Drawee: The buyer or debtor who accepts the bill and promises payment on the due date.
3. Payee: The person to whom payment is made (often the drawer himself or a third party).
4. Discounting Bank: The financial institution that purchases the bill before maturity at a discount and collects payment later from the drawee.

Types of Bills Eligible for Discounting

• Trade Bills: Drawn for genuine commercial transactions between buyer and seller.
• Demand Bills: Payable on presentation and discounted for immediate realisation.
• Usance Bills: Payable after a specified period from the date of drawing or acceptance.
• Clean Bills: Bills not backed by documents of title (e.g., railway receipts or bills of lading).
• Documentary Bills: Bills accompanied by shipping and other commercial documents.

Banks generally prefer trade bills backed by genuine sales and accepted by reputable buyers, reducing default risk.

Process of Bill Discounting

1. Submission of Bill: The drawer submits the accepted bill of exchange to the bank for discounting.
2. Verification: The bank verifies the authenticity of the bill, including the genuineness of the transaction and creditworthiness of the drawee.
3. Discounting: The bank deducts the discount (interest) for the period remaining until the bill’s maturity.
4. Credit to Drawer: The discounted amount is credited to the drawer’s account, providing immediate liquidity.
5. Collection on Maturity: The bank presents the bill to the drawee for payment on the due date.
6. Settlement: Upon payment, the transaction is closed; if the drawee defaults, the bank recovers the amount from the drawer.

Accounting Treatment

In accounting, when a bill is discounted, the drawer’s cash account is debited and the bill receivable account is credited. If the bill is dishonoured, the liability reverts to the drawer, who must repay the bank with applicable charges.
Example:

• When the bill is discounted:Bank Account Dr.To Bills Receivable Account
• On dishonour:Debtor’s Account Dr.To Bank Account (including noting charges)

Advantages of Bill Discounting

• Immediate Liquidity: Converts credit sales into cash, helping maintain business cash flow.
• Short-Term Finance: Serves as a convenient and flexible source of working capital.
• Risk Mitigation: The bank assumes the collection responsibility, reducing the seller’s burden.
• No Collateral Required: Bills are self-liquidating instruments backed by genuine trade transactions.
• Credit Discipline: Encourages formal documentation and accountability in trade credit.
• Improved Cash Management: Enables businesses to match cash inflows with operational needs.

Disadvantages and Limitations

• Cost of Discounting: The interest or discount charge reduces the actual cash received.
• Credit Risk: If the drawee defaults, the drawer remains liable to repay the bank.
• Limited Tenure: Applicable only for short-term financing, usually up to 90 or 180 days.
• Selective Availability: Banks prefer discounting bills of reputed and financially sound parties.
• Documentation Requirement: Requires formal acceptance and verification of trade transactions.

Bill Rediscounting

Rediscounting refers to the process by which a bank that has already discounted a bill sells it to another financial institution or the central bank (such as the Reserve Bank of India) before maturity. This provides liquidity to commercial banks and supports the overall credit system.
In India, the Bill Rediscounting Scheme was introduced by the RBI to promote bill financing and discourage cash credit dependency. Under this scheme, eligible bills arising from genuine trade transactions can be rediscounted with approved financial institutions.

Bill Discounting vs. Factoring

Although both bill discounting and factoring provide short-term liquidity against receivables, they differ in nature:

Role in the Banking System

Bill discounting forms a vital part of the money market and helps maintain liquidity in the economy. It supports the flow of credit among trade participants and fosters discipline in commercial transactions. By discounting bills, banks earn interest income and promote productive credit deployment.
The Reserve Bank of India has consistently encouraged the use of bill finance as a tool for liquidity management and reduction of excessive reliance on cash credit systems.

Recent Developments

In modern banking, digital platforms and trade finance systems have simplified bill discounting. The Trade Receivables Discounting System (TReDS), introduced by the RBI, allows Micro, Small, and Medium Enterprises (MSMEs) to discount invoices or bills online through multiple financiers, ensuring timely payments and improving access to working capital.
The TReDS mechanism has significantly enhanced transparency and competition in bill discounting, reducing financing costs and delays for small businesses.

Economic Significance

Bill discounting plays an integral role in facilitating commercial trade by bridging the gap between supply and payment. It ensures steady cash flow for producers and traders, encourages formal trade documentation, and contributes to the stability of financial markets. For developing economies like India, it supports small enterprises and strengthens the linkage between industry, banking, and commerce.