In this post, we’re delving into a financial concept that might pique your interest— bill discounting or invoice discounting.
You might have heard of it because of the marketing efforts of many startups stating, “It’s not just for High Net-worth Individual (HNI); it can be an investment avenue for retail investors too!”
But is it something you, as an individual investor, should explore? Let’s break it down.
Estimated read time: 4 minutes and 33 seconds
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Buckle up. Here we go!
Understanding Bill Discounting
Imagine you’re a producer financing a movie. You’ve completed shooting and are eagerly awaiting the film’s release. However, you’re strapped for cash as most of your funds are tied up until the movie hits the theatres and starts raking in profits.
So, you have sold your movie’s streaming and music rights to Netflix and T-Series. But neither of these companies will pay you immediately. They have a credit period and will pay you after 60 to 90 days.
But you need money to promote your movie and pay bills. Here’s where bill discounting swoops in to save the day.
Instead of waiting for the payment from Netflix and T-Series, you sell the rights to future earnings (the bill) at a discounted rate to a financier, say a bank or an investor. This allows you to receive immediate funds to cover production costs and marketing or even start work on your next cinematic masterpiece.
Let’s say you were about to receive ₹100 crores from Netflix and T-series at the end of 90 days. You sell this bill to an investor at a discount of 3%. The investor pays you ₹97 crores right away. At the end of 90 days, the investors receive ₹100 crores from Netflix and T-series.
That’s a return of 3.09% in just 90 days, and the annualized return is 12.74%.
An invoice or bill discounting mechanism is used in all industries to solve their working capital issues whenever a bank loan is not feasible. In simple terms, bill discounting is like getting a loan but using your unpaid bills as collateral.
A few years back, retail investors had no option to invest in bill discounting but these days many platforms like Kredx, Grip Invest, ClearTax, BetterInvest and others are providing the opportunity to individual investors like us to invest in bill discounting.
The Pros and Cons of Investing in Bill Discounting
Benefits:
- Quick Returns: This can be a lucrative opportunity to earn quick returns by purchasing bills at a discount, and unlike long-term investments, this typically offers quicker returns as the maturity period is shorter.
- Diversification: Bill discounting can add variety to your investment portfolio, spreading the risk across different assets.
- Potential for Higher Returns: Depending on the terms, it might offer better returns than some other investment options.
Drawbacks:
- Risk Factor: There’s no free lunch! Higher returns often come with higher risks. There’s a chance that the company whose invoices you’ve financed may face financial difficulties, leading to delays or defaults in payment.
- Complexity: Understanding the complexities of bills, creditworthiness, and legalities can be challenging.
- Limited Control: Unlike some investments, you don’t have direct control over whether the company pays up on time. Also, legally, bill discounting is considered an operational debt of a company and is given lesser priority during bankruptcy proceedings.
- Liquidity Concerns: Unlike stocks or bonds traded on exchanges, these investments might lack immediate liquidity. Your money might be tied until the invoice is settled, which could take time.
- Higher Capital Requirements: The minimum investment amount in bill discounting through all the platforms available in India is above ₹50,000. Some platforms also have a minimum investment requirement of ₹3 to ₹5 lakhs.
The drawbacks of investing in bill discounting are pretty strong. If you still want to invest in it, you should know that bill discounting falls under alternative investments.
What are Alternative Investments?
An alternative investment is a financial asset that does not fall into one of the traditional investment categories which are stocks, bonds, fixed deposits, gold or cash.
Alternative investments include hedge funds, private equity, art, P2P lending, bill or invoice discounting, cryptocurrency, etc.
These alternative investments often present unique risk-return profiles and may not correlate with traditional markets.
They can offer potential diversification benefits and the opportunity for higher returns but typically come with higher risks and illiquidity, and often require more expertise to understand and manage effectively.
Investors often explore these avenues to diversify their portfolios and seek returns not tied to the traditional stock and bond markets.
When Should You Invest in Alternative Investments?
Imagine your investment journey as a gear-shift experience, much like driving a car or riding a bike. Just as you start from the lower gears and gradually move up for a smoother ride, your financial journey follows a similar trajectory.
In this analogy, the initial gears represent laying down a solid foundation for your financial security:
- 1st Gear: Start by building an emergency fund and securing yourself with life and health insurance. This acts as your starting point, providing stability and protection against unforeseen events.
- 2nd to 4th Gears: As you gain momentum, transition into traditional investments like equities and debt. These gears symbolize investing towards your goals, whether it’s buying a home, planning for retirement, or achieving other milestones.
And then, there’s the ultimate gear – the 5th gear – where alternative investments come into play:
- 5th Gear: This is where alternative investments shine. Think of it as the pinnacle of your financial journey. When you’ve successfully manoeuvred through the initial gears, have a surplus of funds, a good appetite for risk, and the expertise to understand these investments, you can consider diversifying further with alternatives.
Just as shifting to a higher gear in a vehicle requires both readiness and a smooth transition, venturing into alternative investments demands a similar approach in your financial journey. It’s not about starting directly in the highest gear but gradually working your way up, ensuring a balanced and stable ride.
By moving through these gears methodically, addressing your immediate financial needs first, then advancing towards long-term goals with traditional investments, you set the stage for potentially exploring the world of alternative investments when the time is right – and when you’re fully prepared for the ride.
However, just like shifting to the 5th gear isn’t compulsory, investing in alternative investments isn’t a strict endpoint.
If you’ve got surplus funds, a robust risk appetite, and a knack for diversification and want to explore alternative investment assets then you can invest in them.
Remember, there’s no one-size-fits-all rule. While it’s prudent to establish the basics first, it’s not mandatory to fulfil every requirement before delving into alternative investments.
You might choose to dip your toes into alternatives early on, but maintaining a balanced portfolio is key. Consider keeping your exposure to alternative assets within 3 to 5% initially. Over time, as your expertise grows, you can gauge the ideal percentage for your portfolio.
Your investment journey is unique. It’s about finding the right pace and balance. Start steady, master the essentials, and when the time feels right, explore the world of alternative investments while keeping your overall portfolio diversity in mind.
Share these insights with your buddies. Until next time!
Still Curious?
If you are like us, who likes to analyse a little more or check out content in different formats, well you are in luck. Below you can find some suitable content we found.
Ankur Warikoo – What is Invoice Discounting?
CA Rachana Ranade – What is Invoice Discounting? | Low Risk High Return Investments
Mint – It’s now time to regulate invoice discounting
Note: We don’t have any affiliation with them. We are sharing links only for educational purposes. The opinions expressed by them belong solely to them and do not reflect the views of Vrid.