Discounting - Factoring

8/9/2019 Discounting - Factoring

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Discounting &Factoring

(A Presentation of Banking & Financial Markets )


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Discounting

Discounting simply means, multiplying

an amount by a discount rate & then

subtracting from principal to computeits present value (the 'discounted value').


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Bill of exchange can be discounted before its

maturity date.

It is basically a three-party negotiable instrument in

which; The first party, the drawer, presents an order for the

payment of a sum certain on a second party, the drawee,

for payment to a third party, the payee, on demand or at

a fixed future date.


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What if the payee needs the payment before thematurity date???

The bill can be presented for discounting to the bank


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Three major things to notice when the bill is

being presented for discounting;

The signature as well as credit limit of the banksborrowers have been verified.

The original tenor of the bill does not exceed 120

days ifBill Discounting Facility is to be availed of.

The payment instructions and maturity date areclearly mentioned on the bill.


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Discount Rate:

The rate at which the bill is discounted i.e. the rate

at which the present value of the bill is calculated.

Tenor (Discount period):

The period between the date of discounting and the

future due date that is written on the bill.

Discount fee: A fee is charged for discounting the bill. It varies

from bank to bank. And its not higher as well.


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Example;

A person XYZ comes to the bank and wants to

discount his Bill ofExchange of Rs. 500, 000/- on

June 1, 2009-. The maturity date ofBill ofExchange

is August 15, 2009.


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The bank decides to purchase it at a discount rate of 10%.

Total number of days= 75 days

DiscountAmount= 500,000*10%*75/365= 10274

The person XYZ will get 500,000 10274 = 489726

This shows bank has purchased the bill at the price of 489726

And after 75 days the bank will make profit of 10274.


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Bill ofExchange has the advantage of reselling

many times before the maturity date.

Every time it is sell a stamp ofEndorsement (Asignature used to legally transfer a negotiable

instrument) is placed for the prove on the bill.


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Continuing with theexample:

For example the bank sells this bill to another bank

ABC when there were 50 days to maturity. The bill

was discounted by bankABC at the rate of 9%


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The tenor = 50 days

Discount rate = 9%

Discount amount = 500,000 * 9% * 50/365

= 6164

The bank gets = 500,000 6164

= 493836

Profit that bank gets = 493836 489726

= 4110

The purchasing price for the bankABC = 493836

After 50 days the BankABC will get the profit of 6164.


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Advantages

To Banks:

S

afety of Funds. (signed by the parties. Its a promisethat they will get their amount back)

Profitability. (by re-investing it/utilizing it)

The buyer of the bill expects to make a profit by purchasing

the bill at a discount to its face value & then either receiving

full payment at maturity or reselling the bill before maturity. No change in the face value of the bill.


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Advantages

To the payee who comes for discounting

G

etting immediate cash Normally lower discount rates


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Factoring

The selling or transferring of accounts

receivable to a third party in order to gain

funds that are immediately available. The purchase is made at a discount from the

account's value.


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Three parties are involved in it;

Factor

A company sells its receivables to another company,

which is called a factor.

Selling Company (Customer)

Buyer ( debtor )


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For Example;

A company ABC sells its machinery to XYZ and

creates an invoice. The Company ABC needs the

cash, so it will go the bank and will sell its invoices

(Accounts Receivables) at a discount to get

immediate cash.

Bank Factor

Company ABC Seller

XYZ Debtor


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Types of factoring


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Example:

ACompany XYZ has sold the invoices of amount Rs.

500,000/-. The selling company goes to the bank to

discount its invoices that are receivable in 2

months. In contract it is decided to pay 85% of the

invoices in advance.

Payment made by factoring company = 500,000*.85

= 425,000


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Assume that after 2 months the bank collected only400,000 of invoices


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With RecourseWithout Recourse

The bank will have the loss of:= 425,000 400,000

= 25,000

Plus all the interest & charges.

The factor is at risk

The Selling Company (Customer)will itself pay the bank the

remaining payment which is not

collected:

= 425,000 400,000

= 25,000

Plus all the interest & charges.

The factor is not at risk


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Advantages of Factoring (to Selling

company):

Get money quickly Avoid thehassle of collecting baddebt

Under the agreement of without recourse

Borrow money, secured by your debt

Smooth your cash flow


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Disadvantages:

Higher cost of factoring

the fact that sellers clients have to deal with thefactoring companies


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Similarity

Discounting & factoring both provides the

ready & immediate cash (finance) rather than

waiting for the maturity date.


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Differences

FactoringDiscounting

Discounting is done for:

Bills ofExchange under L/Cs.BankersAcceptance.

Promissory Notes

Factoring is done for:

Receivables receipts/ invoices.

Discounting of bills can be donemany times before reaching the

maturity date.

In factoring the accountsreceivables once purchased

can not be resell.


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Differences


In case of discounting the bank

dont have to bear the risk of

repayment.

In case of factoring without

recourse the bank have to bear

the risk of the collection of

receivables.

Discounting charges are muchlower.

Factoring charges are higher as

the factor is also maintainingthe sales ledger of the

company plus bearing the risk

of repayment.


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Differences


Companys profile/performancedoes not matter a lot.

Companys profile/ performance

is considered highly. Only those

companies which have good

profitable profiles are selected.


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THANK YOU

Documents

Discounting - Factoring