Discounting of Bills: Meaning, Accounting, Formula, Examples, and Importance

 

Definition of Discounting of Bills

Discounting of bills refers to the process in which the holder of a bill of exchange sells it to a bank or financial institution before its maturity at a price lower than its face value. The difference between the bill’s face value and the amount paid by the bank is known as the discount, which acts as the bank’s income for taking the risk of early payment.

Meaning of Discounting of Bills

In business transactions, buyers often purchase goods on credit and issue a bill of exchange in favor of the seller (drawer). Instead of waiting until the bill matures to receive the payment, the seller can approach a bank and discount the bill.

The bank immediately pays the seller the bill amount minus a discount (interest charges) for the remaining period till maturity. The bank then collects the full amount from the drawee (buyer) on the due date.

This practice is common in trade and finance, as it helps businesses maintain liquidity and meet working capital needs.

Concept of Discounting of Bills Explained

• Bill of Exchange: A written order by the drawer (seller) directing the drawee (buyer) to pay a certain sum to the payee on a specific date.

• Discounting: Selling the bill to a bank before maturity at a price lower than its face value.

• Discount: The bank’s income, representing the interest charged for the time left until maturity.

Essentially, discounting of bills bridges the gap between credit sales and cash flow needs.

Formula for Discounting of Bills

The calculation of the discount can be expressed as:

$$\text{Discount} = \text{Bill Amount} \times \text{Rate of Interest} \times \frac{\text{Unexpired Period (in months or days)}}{12 \text{ months or 365 days}}$$ $$\text{Proceeds} = \text{Bill Amount} - \text{Discount}$$

Example Calculation

Suppose a bill of ₹1,00,000 is drawn for 3 months and is discounted with a bank at 12% p.a. after 1 month.

• Bill Amount = ₹1,00,000

• Unexpired Period = 2 months

• Rate = 12% p.a.

$$\text{Discount} = 1,00,000 \times 12\% \times \frac{2}{12} = ₹2,000$$
$$\text{Proceeds} = 1,00,000 - 2,000 = ₹98,000$$

Thus, the seller receives ₹98,000 immediately, while the bank collects ₹1,00,000 from the buyer at maturity.

Journal Entry in Accounting

When a bill is discounted with the bank, the following entry is passed:

At the time of discounting the bill:

Bank A/c                  Dr   ₹98,000  
Discount A/c              Dr   ₹2,000  
   To Bills Receivable A/c      ₹1,00,000  

At maturity (when drawee pays to bank):
No entry is required in the books of the drawer, as the transaction is already settled.

Detailed Illustration

A trader holds a bill receivable worth ₹50,000 due in 90 days. After 30 days, he needs cash and discounts the bill with a bank at 10% p.a.

• Unexpired Period = 60 days = 60/365 years

• Discount = ₹50,000 × 10% × 60/365 = ₹822 approx.

• Proceeds = ₹50,000 – ₹822 = ₹49,178

Journal Entry:

Bank A/c                  Dr   ₹49,178  
Discount A/c              Dr   ₹822  
   To Bills Receivable A/c      ₹50,000  

Key Features of Discounting of Bills

• Involves a bill of exchange.

• Provides immediate liquidity to the drawer.

• Bank charges discount (interest).

• Risk of dishonor shifts to the bank.

• Widely used in trade and commerce.

Importance in Business

• Ensures Cash Flow: Helps businesses meet short-term financial needs.

• Boosts Trade: Encourages credit sales by providing liquidity.

• Supports Growth: Provides working capital for expansion.

• Financial Leverage: Allows businesses to use future receivables today.

Advantages and Disadvantages

Advantages

• Quick liquidity for the seller.

• No additional collateral required (bill acts as security).

• Helps maintain credit cycle.

Disadvantages

• Costly due to discount charges.

• If the bill is dishonored, liability may return to the drawer.

• Dependence on banks for liquidity.

Usage of Discounting of Bills

• Used by exporters to get advance against bills.

• By manufacturers for working capital.

• By trading firms to manage receivables.

• By banks as a source of short-term income.

Case Study Example

Case: Export Industry in India
An exporter sells goods worth ₹10,00,000 to a foreign buyer, payable after 6 months. Instead of waiting, the exporter discounts the bill with a bank at 8% p.a.

• Discount = ₹10,00,000 × 8% × 0.5 = ₹40,000

• Proceeds = ₹9,60,000

This immediate liquidity enables the exporter to fund production and continue trade, highlighting how bill discounting supports international trade finance.

Table Example

Particulars	Amount (₹)
Bill Amount	1,00,000
Rate of Interest	12% p.a.
Unexpired Period	2 months
Discount	2,000
Proceeds to Drawer	98,000

Practical Example

A textile company receives a bill of ₹5,00,000 from its customer, payable after 4 months. To pay salaries, it discounts the bill after 1 month at 15% p.a.

• Unexpired Period = 3 months

• Discount = ₹5,00,000 × 15% × 3/12 = ₹18,750

• Proceeds = ₹4,81,250

Common Mistakes or Misunderstandings

• Confusing discounting of bills with trade discount.

• Ignoring bank charges while calculating proceeds.

• Believing bill discounting eliminates all risk—dishonor risk may come back to drawer.

• Misapplying interest rate for days vs. months.

Real-Life Applications

• Export Finance: Discounting of export bills through banks.

• Corporate Finance: Large companies use it for working capital needs.

• Banking Operations: A core product for banks.

• SMEs: Reliance on bill discounting for day-to-day liquidity.

• Legal Implication: Governed under the Negotiable Instruments Act, 1881 in India.

FAQs

Q1. Is discounting of bills a loan?
No, it is not a loan. It is a purchase of a bill by the bank at a discounted value.

Q2. What happens if the bill is dishonored?
The bank recovers the amount from the drawer (seller) since the liability ultimately lies with the drawer.

Q3. Is bill discounting and factoring the same?
No. Factoring involves selling receivables, while bill discounting deals with bills of exchange only.

Q4. Which Act governs discounting of bills in India?
The Negotiable Instruments Act, 1881.

Expert Tip from Learn with Manika

“Always calculate the cost of discounting versus other financing options. Sometimes short-term loans may be cheaper than heavy discount charges.”

Related Terms

• Bill of Exchange
• Factoring
• Promissory Note
• Trade Discount
• Working Capital Finance
• Negotiable Instruments