Discounting &

Factoring
(A Presentation of Banking & Financial Markets )
Discounting
 Discounting simply means, multiplying
an amount by a discount rate & then
subtracting from principal to compute
its present value  (the 'discounted value').
 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.
Orders drawee to
pay a certain amount
of payment at a
certain date,
mentioned on
negotiable
instrument
Drawer Drawee (bank) Payee
 What if the payee needs the payment before the
maturity date???

The bill can be presented for discounting to the bank

 Three major things to notice when the bill is
being presented for discounting;
 The signature as well as credit limit of the bank’s
borrowers have been verified.
 The original tenor of the bill does not exceed 120
days if Bill Discounting Facility is to be availed of.
 The payment instructions and maturity date are
clearly mentioned on the bill.
 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.
 Example;
 A person XYZ comes to the bank and wants to
discount his Bill of Exchange of Rs. 500, 000/- on
June 1, 2009-. The maturity date of Bill of Exchange
is August 15, 2009.
 The bank decides to purchase it at a discount rate of 10%.

 Total number of days= 75 days

 Discount Amount= 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.

 Bill of Exchange has the advantage of reselling
many times before the maturity date.
 Every time it is sell a stamp of Endorsement (A
signature used to legally transfer a negotiable
instrument) is placed for the prove on the bill.
 Continuing with the example:
 For example the bank sells this bill to another bank
ABC when there were 50 days to maturity. The bill
was discounted by bank ABC at the rate of 9%
 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 bank ABC = 493836
 After 50 days the Bank ABC will get the profit of 6164.
 Advantages
 To Banks:
 Safety of Funds. (signed by the parties. It’s a promise
that 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.
 Advantages
 To the payee who comes for discounting
 Getting immediate cash
 Normally lower discount rates
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.
 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 )
 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
 Company ABC
sells its goods and
creates an invoice

Company ABC sells its invoices to the

Factor (Bank), as per the contract.
(what percentage to advance, what will be
discount rate, charges etc)

Factor verifies the Factor fund Company ABC

invoices with the (Seller) (lets assume 80% is
Buyer (XYZ) / decided in contract) 80% of
Debtor the invoice immediately

There are two methods

The remaining 20% is
for the collection of
not paid until the
payments… we will
collection of
discuss it in a while in
receivables
next slide

Collection of payment
from the Debtor (XYZ)

The Factor now cut its charges

as per written in the contract
and credit the remaining
balance to the Company ABC
(Seller’s) Account.
Types of factoring
Factoring

Without Recourse With Recourse

means that the

means that the
company that buys
company that
the accounts
originally sold the
receivable bears the
goods will be liable
risk of repayment.
to the purchaser if
the receivable is not
collected.
 Example:
 A Company 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
Assume that after 2 months the bank collected only
400,000 of invoices
Without Recourse With Recourse

The bank will have the loss of: The Selling Company (Customer)
= 425,000 – 400,000 will itself pay the bank the
= 25,000 remaining payment which is not
collected:
Plus all the interest & charges. = 425,000 – 400,000
= 25,000
 The factor is at risk
Plus all the interest & charges.

 The factor is not at risk

 Advantages of Factoring (to Selling
company):
 Get money quickly
 Avoid the hassle of collecting bad debt
 Under the agreement of without recourse
 Borrow money, secured by your debt
 Smooth your cash flow
 Disadvantages:
 Higher cost of factoring
 the fact that seller’s clients have to deal with the
factoring companies
Similarity
 Discounting & factoring both provides the
ready & immediate cash (finance) rather than
waiting for the maturity date.
Differences
Discounting Factoring
Discounting is done for:    Factoring is done for:
•Bills of Exchange under L/Cs. •Receivables receipts/ invoices.
•Bankers Acceptance.
•Promissory Notes

Discounting of bills can be done In factoring the accounts

many times before reaching the receivables once purchased
maturity date. can not be resell.
Differences
Discounting Factoring

In case of discounting the bank In case of factoring without

don’t have to bear the risk of recourse the bank have to bear
repayment. the risk of the collection of
receivables.

Factoring charges are higher

Discounting charges are much as the factor is also
lower. maintaining the sales ledger of
the company plus bearing the
risk of repayment.
Differences
Discounting Factoring

Company’s profile/performance Company’s profile/ performance

does not matter a lot. is considered highly. Only those
companies which have good
profitable profiles are selected.
THANK YOU