If the drawer of the bill does not want to wait till the due date of the bill and is in need of money, he may sell his bill to a bank at a certain rate of discount. The bill will be endorsed by the drawer with a signed and dated order to pay the bank. The bank will become the holder and the owner of the bill. After getting the bill, the bank will pay cash to the drawer equal to the face value less interest or discount at an agreed rate for the number of days it has to run. This process is know as discounting of a bill of exchange. From the other side, it is a business vertical for all types of financial intermediaries such as banks, financial institutions, NBFCs, etc.
For example, a drawer has a bill for 10,000. He discounted this bill with his bank two months before its due date at 15% p.a. rate of discount. Discount will be calculated as the follow:
1,000 × 15/100 × 2/12 = 250
Thus the drawer will receive a cash worth 9,750 and will bear a loss of 250.
The bank will keep this bill in possession till the due date. On maturity (due date) the bank will present the bill to the acceptor and will receive cash from him (if the bill is honored). In case, the acceptor does not make the payment to the bank, then the drawer on any person who has discounted the bill have to take this liability and will pay cash to the bank.
Until the bill is honored on the due date, there is always a chance that the drawer will become liable on the bill. This is called a contingent liability – a liability that will only arise if a certain event occurs – the acceptor does not honor the bill.
Bills may be presented to the nominated bank in two ways:
We check the documents and confirm that they comply with the DC terms, and send the bill with the original DC to the nominated bank requesting payment. The nominated bank need not recheck the documents and it can claim a refund from us in the case of an unspotted discrepancy. We pay our customer after receipt of funds from the nominated bank.
We pass the original DC and unchecked documents to the nominated bank on a collection basis, requesting payment. The nominated bank has to check the documents in the normal way. Usually, we present documents to the nominated bank without recourse.
BILL DISCOUNTING PROCESS/PROCEDURE
♦The seller sells the goods on credit and raises invoice on the buyer.
♦The buyer accepts the invoice. By accepting, the buyer acknowledges paying on the due date.
♦Seller approaches the financing company to discount it.
♦The financing company assures itself of the legitimacy of the bill and creditworthiness of the buyer.
♦The financing company avails the fund to the seller after deducting appropriate margin, discount and fee as per the norms.
♦The seller gets the funds and uses it for further business.
♦On the due date of payment, the financial intermediary or the seller collects the money from the buyer. ‘Who will ♦collect the money’ depends on the agreement between the seller and financing company.