Discount credit to finance growth

Discount credit is a technique used to realise receivables in order to deal with cash flow shortages resulting from the terms of payment given by businesses to their customers. Through this form of credit, the bank pays the amount corresponding to a commercial paper before its due date, deducting a fee in proportion to the value of the commercial paper (or bill), the time remaining until maturity and the discount rate given. Discountable bills are, in particular, bills of exchange, commercial papers, promissory notes and, in some cases, warrants.

The administrative burden associated with discount credit means that it is seldom used and that factoring is opted for instead.

Objective: it is used to finance the operating cycle and the working capital and cash flow requirements resulting from late payment by customers.

Who is concerned

Available to the self-employed and any type of business, but in particular commercial businesses involved in the purchase and sale of goods, discount credit applies in the following cases:

  • growth of the business;
  • relatively long operating cycle;
  • large invoices;
  • long terms of payment given to customers;
  • cash payment of suppliers.
Example: a trader gives his customer a term of payment, but since he needs funds to finance his activity, he seeks to realise his receivable. To do this, the customer must undertake in writing to pay his supplier on the agreed due date. The trader submits this signed document, called "commercial paper", to the bank and asks for discount credit.
If this is accepted, the bank converts the bill into cash which is advanced to the trader. The trader can then honour his commitments (rent, salaries, etc.). On the due date, the bank will collect the amount of the bill from the buyer.

Prerequisites

Documentation or description of the business

  • copy of the company’s articles of association;
  • group structure if the company is part of a more complex group;
  • last 3 audited balance sheets of the borrower and, if applicable, the latest available trial balance;
  • recent supporting documentation regarding VAT, tax and social security situations;
  • order book (where applicable);
  • list of customers and their relative contribution to turnover;
  • list of suppliers.

Presentation of the application

  • debt security (commercial paper, bill of exchange, promissory note, etc.);
  • cash flow statement;
  • forecast budget showing future working capital requirements;
  • presentation and analysis of the quality of the third parties involved (customers or suppliers).

Guarantees

Discounting commercial paper is a safe and liquid transaction; the conclusion of the underlying commercial transaction ensures the collection of funds for repayment. It is therefore a self-liquidating credit, for which banks do not generally ask for tangible guarantees.

The discount transaction in itself provides the bank with the following guarantees:

  • by endorsement, the bank becomes the owner of the bill;
  • it obtains recourse against all signatories through the endorsement;
  • by virtue of the "recourse on a bill of exchange", the drawer assigning the receivable stands surety for the payment;
  • in the event of non-payment on the due date, the bank has the right to debit the drawer’s account.

Depending on the quality of the business and the length of its relationship with the bank, the bank may request the following additional guarantees:

  • the pledging of an account fed by withholding a certain percentage of the bills for discount;
  • assigning the cover provided by a credit insurance policy;
  • surety of the parent company or partners/shareholders;
  • various moral guarantees.

When the partners/shareholders of a business have to stand surety for the company, the bank should be provided with the details of their financial situation.

How to proceed

Duration and amount

Duration

There are 4 ways to set the due date:

  • sight bill: payable on presentation of the paper, but within a year;
  • bill after sight: payable after having been presented for acceptance with respect to the period indicated on the commercial paper;
  • bill after date: payable during the period indicated on the commercial paper;
  • date bill: payable on the date specified in advance.

Amount

The amount is indicated on the bill of exchange or the commercial paper.

Interest rate

The cost of discount credit is made up of the following elements:

  • discounting commission: groups together the collection, acceptance and settlement commissions;
  • discount tax: fixed flat-rate fee per transaction;
  • debit interest due on the nominal amount of the commercial paper, for the remaining period. This is made up of:
    • a basic rate: the discount rate is a variable rate that is usually lower than the basic rate for overdrafts or current account advances;
    • a fixed margin determined according to the quality and risk of the borrower and the amount of the bill of exchange.

The costs can be significantly lower if the bill is domiciled in a bank and/or payable in Luxembourg.

Repayment

On the due date, the bank is paid by the drawee that owes the amount indicated on the debt security. Failing this, it shall send a notice of non-payment to the drawer. The bank effectively provides an advance and purchases a receivable, but it does so subject to collection. If it is not settled by the drawee, it must be settled by the drawer (recourse on a bill of exchange).

Set-up times

The reviewing and processing times depend on the complexity, size and urgency of the case.

Types of discount credit

Supplier discount credit

The business (buyer) can pay its suppliers in cash without immediately using its financial resources and thus take advantage of more favourable conditions (reductions or discounts). In this case, the buyer creates a bill for which it is the drawee and the supplier is the drawer (beneficiary). The credit is thus granted to the drawee (buyer), which asks its bank to discount the bill, with the drawee liable for all the associated costs. The supplier thus receives the nominal amount of the bill immediately.

Assignor or customer discount credit

The bank discounts bills drawn by its customer (the drawer or the seller) on the latter’s customers (the drawees or buyers). In this way, the business (the seller and the bank’s customer) is paid in cash, while giving its buyers a payment extension. The credit is then given to the drawer (the seller).

Advantages, disadvantages and risks

Advantages

  • reduction in cash flow shortages resulting from a gap between the payment of invoices received and the collection of invoices issued;
  • rapid payment of suppliers so as to benefit from significant discounts;
  • immediate release of funds which would otherwise be tied up until the due date;
  • collection of bills by the bank, which prevents deferments (the debtor would not feel as comfortable asking the bank for a deferment as he would the seller);

Disadvantages

  • administrative burden, since each bill discounted is subject to the bank’s approval;
  • the bank requires credit insurance;
  • reduced flexibility with regard to adapting the bills for discount to actual cash flow requirements, in respect of both amount and period;
  • payment of agios and commissions for amounts and periods that are sometimes greater than the business' real requirements.

Risks

  • discount subject to final collection: if the debtor of the commercial paper does not pay on the due date, the bank may turn to whoever initially granted the credit (right of recourse), i.e. its customer. The customer remains jointly and severally liable. It is a shared risk;
  • legality of the bill for discount: fraud is sometimes carried out, with falsified bills or accommodation bills not corresponding to any underlying economic service being presented. This is one of the reasons why banks rarely give discount credit to businesses in the process of being set up or recently set up;
  • risk of over-concentration with respect to one customer (assignor discount);
  • unpaid discounted bills: for the supplier discount, the borrowing business (buyer) could be included on the list of insolvent businesses, indicating its insolvency.
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