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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.
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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.
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.
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.
