Managing cash flow is one of the primary objectives when operating a business. Small and large businesses alike, on the other hand, always try to keep capital circulating. Ensuring the liquidity of monetary resources is of utmost importance. Businesses have adopted several strategies to access capital immediately. Two of such methods are: early payment discounting and bill discounting.
Even though the terms may seem related, they are rather unrelated. A knowledge of the differences can help formulate better business strategies. The coming section explains the terms, their workings, and the differences in detail.
What is the Meaning of Early Payment Discounting?
In Early payment discount policies, prompt payment becomes a well-practiced courtesy and is considered best practice for suppliers. Buyers take up offered discounts, which enable payment to be recorded even before the specified date.
As an example, consider yourself a supplier who has 10,000 dollars worth of goods. In this scenario, the buyer is most likely to pay the amount in the coming two months if a 60-day quote is provided. But you can give them a 2% discount if they decide to pay in 10 days. If they decide to go with the offer, you receive 9,800 dollars in 10 days, which is better than waiting for two months for 10,000.
The main goal is simple is to improve cash flow, which is always prioritized even if it means giving a portion of profit.
What Are the Steps Involved In An Early Payment Discount?
In essence, the method is simple. A seller will invoice the buyer once they provide the goods or services. An early payment discount will be included while sending the invoice. If the buyer is accepting, payments will be completed ahead of schedule, with the discount taken off. Such practices are common in businesses with mutual trust. The process is straightforward and does not involve banks or other intermediaries.
How is Discounting Receivables Different from the Procedure Above?
This practice is different because it involves a financial institution. In this situation, a seller does not sit back and wait for payment. Rather, he takes the invoice or bill to the bank, and the bank pays part of the drawdown.
The bank will pay a percentage lower than the invoice value. Besides fees and interest, the remaining amount is transferred to the seller immediately. Cash in hand is based on purchases, along with the services purchased. Payment is rendered, with the value deducted based on the dates agreed upon.
For example, you sell $10,000 worth of goods and the buyer promises to pay in 60 days. You go to the bank with the invoice. The bank gives you $9,700 immediately, charging a small fee. When the 60 days are up, the buyer pays the full $10,000 to the bank.
How Does Bill Discounting Work?
Initially, the seller presents the bill of exchange (a form of payment document) to the bank. The bank reviews the payment history and checks the buyer’s credibility. If all goes well, a percentage of the invoice value, usually between 70-90%, is handed out to the seller immediately.
Every due date, the bank is responsible for collecting payment from the buyer. If the buyer does not pay, depending on the agreement, the seller might be on the hook for that. Their involvement requires extra paperwork, credit risk assessment, and verification.
Early Payment Discounting vs. Bill Discounting: Key Takeaways
The following section covers the major differences:
Parties Involved
Only the seller and buyer are involved in early payment discounting. It’s a straightforward interaction between two entities.
In bill discounting, a bank usually joins by adding a third party. This entails additional approval and restrictions, along with added fees.
Process
Discounting for early payment is quick, as it involves an invoice, sending it off, and getting paid in advance if they agree.
A form of invoice discounting known as bill discounting has processes and steps to follow. You send in documentation to the bank or institution, and they check the documentation before you are paid.
Cost
For early payment discounting, costs are what you grant in discounts, like 2% or 3% of the invoice value.
With bill discounting, their costs will also cover bank charges, interest, and payments for processing the bills. In this case, costs will be marginally higher overall.
Risk
Discounting early payment risk is considered low if the buyer is reputable. Everyone wants to sidestep loans and banks.
With bill discounting, risk is largely contingent upon the buyer. If the obligation is not fulfilled, you may still owe the bank money, depending on the agreement terms.
Flexibility
Early payment discounting grants flexibility as you can choose to extend to a few buyers or restrict invoices.
Bill discounting has no flexibility, and once you go to the bank, you have to go through the same formal processes every time.
Which One is Better?
As usual, it depends on the business needs, and the following covers which is good when:
- If you have some trusted clients and can grant a small discount, early payment discounting is an easy and reliable method to optimize cash flow.
- If you deal with new customers or require higher amounts in a short period, bill discounting, despite its additional costs, could be a more advantageous offer.
- Many firms combine both methods. Some clients have their invoices paid early, while others have them billed at a discount.
Why Cash Flow Management is Important
Regardless of whether you prefer early payment discounting or bill discounting, both methods have the same end goal: improved cash flow management.
Enabling you to balance having enough cash enables you:
- Pay your suppliers without delay.
- Manage emergencies.
- Capitalize on new opportunities.
- Maintain effortless operational efficiency.
- Poor cash flow can, however, negatively impact an otherwise profitable business.
Carefully analyze your customers, your monetary needs, and the bank’s perception of your business. Then, determine which method is more effective for your business.
Conclusion
Both forms of payment discounting are effective. They allow companies access to cash that is locked up in unpaid invoices. Early payment discounting is efficient and cost-effective since it involves only two parties. Bill discounting provides greater, rapid access to cash but incurs additional expenses and becomes more complex. Quick approval and transparent pricing set Credlix apart from other companies. They keep up with the digital world by incorporating their exporters and MSME-focused selling services digitally.
