Introduction
Through the merchant discount, one enters fully into debtor management, a theme common to every company that must foresee the time lag between the time of sale and the time of collection, which has financial consequences for its cash management.
Under normal circumstances, the selling company grants its customer a payment term, which implies the granting of a trade credit. The selling company is directly granting financing to the customer, with the possibility that the price includes financial expenses.
One way of being able to influence the payment period from customers, reducing it, is through the use of merchant discount.
Definition
The commercial discount is an operation intended to provide liquidity to the selling companies since it transforms the commercial credits granted to their clients into cash. It is defined as the financial operation by which a credit institution, after deduction of interest, advances to its client the amount of a commercial credit against a third party, provided that it is not due and the assignment is made unless the credit itself is well ended. .
Some details:
- The customer to whom the financial institution advances the amount of the discounted credit is the discounter. A more accepted denomination in banking practice is that of assignor (a term derived from the action of assigning the credits for their discount). It is necessarily a businessperson, since the discount contract was created to meet financial needs derived from economic activities.
- Certain deductions or discounts are applied to the amount of the credit that the assignor presents for discount (the interest for the time remaining until its maturity and the expenses inherent to the management of presentation for collection).
- Merchant credit means the amount indicated in trade documents that evidence commercial transactions (sale of goods and provision of services) carried out, the payment of which has been deferred in whole or in part.
- It must be a claim against a third party. A claim against the same assignor would be extinguished due to confusion (it is not possible to be both a creditor and a debtor).
- It is not enough that the credit refers to money, but the amount has to be absolutely determined.
- They must be specific term credits. Interest is calculated by the time that elapses between the discount date and the credit expiration date.
- The assignor transfers to the credit institution the legitimate ownership of the collection right embodied in the document.
- The clause “subject to collection” means that the advance paid by the institution to the assignor is linked to a defeasance clause, so that if the third party debtor does not pay the discounted credit to the institution on the day of maturity (that is, if it does not collect the money), the credit institution takes action against the assignor, charging them the nominal amount of the assigned credit in their account and immediately claiming the payment thereof.
On the other hand, the merchant discount is associated with a series of costs:
- Supervision of the agreement by a Notary Public, in the event that a standard-form agreement is concluded with its respective limits, conditions, etc., to provide for eventual and various future discounts for the same client.
- Interest: Normally interest is charged in advance, that is, “all at once”, depending on the time remaining for the maturity of the instrument.
- Stamp tax: For those documents that do not include the relevant stamp, the financial institution will act as an intermediary for the Tax Authority, charging a tax on the nominal amount of the remittance.
- Most frequent commissions:
- Minimum fee charged by the financial institution for each discounted instrument.
- Acceptance fee: Commission that must be paid by the client (assignor) in case the instrument is not accepted, since it is then the financial institution that takes the appropriate steps to get acceptance of the instrument. This fee is charged by instrument and its amount depends on whether it is direct debited or not.
Given that, in most cases, the merchant discount is made by adding the clause “subject to collection”, in case of non-payment of the instrument at maturity by the drawee, the financial institution will return the instrument to the client (assignor) and will claim the amount that it advanced, as well as the corresponding commissions and expenses, these being basically the following:
- Commission for return: Commission that must be paid by the client (assignor) in the event that upon expiration of the instrument, it is unpaid.
- Commission for management of protest by Notary Public.
- Commission for management of statement of non-payment.
Purpose
The commercial discount is an important means of business financing. It allows advancing the amount of the debt undertaken by customers, without having to wait for the agreed term to elapse, which allows the amount received in the operation of the business to be reinvested immediately.
In this way, it exerts a higher turnover effect on current assets, since it reduces the maturity period by directly affecting the trade debtors collection period.
On the other hand, although on a second level in importance, it relieves the company of the administrative management involved in the collection of claims that have been assigned.
Types of comercial discount
a. According to the frequency with which it is carried out.
- Isolated or circumstantial discount: This is the name given to sporadic discount transactions carried out by a businessperson who does not regularly resort to discount.
- Discount facility or negotiable instrument advance: This is the case in which a normal discount practice occurs. The credit institution undertakes to discount the claims presented by its client, for a period and up to a certain amount.
It is important to clarify that the credit institution does not undertake, in any case, to discount any claim that the assignor presents for discount, but reserves the right to examine the quality of the instruments to decide which ones to discount and which ones not.
The negotiable instrument advance can be in turn:
- Revolving: It is allowed to cover the risk cancellations produced by new transactions up to a certain amount, which will be the very limit of the advance.
- Non-revolving: It is not possible to cover the risk cancellations that occur with new transactions.
An example is provided below to illustrate the needs met by a negotiable instrument advance. Suppose a company with a turnover of 20 million of c.u. (evenly distributed throughout the year), whose sales collection is always deferred to 90 days, and to which is usually advanced 50% of such turnover through discount.
The instrument drawn to its customers has a rotation of a number of four times a year (payment deferred to 90 days, then 90 x 4 = 360).
The revolving discount facility that would meet its needs over a one-year term should have a limit amount of 2,500,000 c.u. Revolving it according to the term of the instrument (four times a year) allows the annual discount that the company requires.
b. According to the responsibility of the assignor.
- With recourse: It is the most normal case of merchant discount. The assignor carries out the assignment of the document “subject to collection”, so that, if it is unpaid, the credit institution that discounts the instrument has the recourse to demand payment from the assignor.
- Without recourse: It is the exception. In the event of non-payment of the assigned claim, the institution that discounted it will not be able to demand payment from the assignor, which is only liable for the existence and legitimacy of the claim that it transfers, that there is a trade relationship that justifies the existence of the assigned instrument, that the claim is not extinguished and that it does not suffer from vices that could cancel it; in short, that there are no causes other than the insolvency of the obligor that justify the non-payment of the discounted instrument. Obviously, this type of discount implies a greater risk for the credit institution than the “with recourse” discount. In this case, the success of the discount rests solely on the solvency of the obligor.
c. According to the existence or not in physical format.
In addition to the conventional discount, the one in which the assignor delivers the physical document to the credit institution (bills, promissory notes, receipts, etc.), there is another type of discount whereby the physical document is replaced by magnetic media or a files transfer from the transferor to the credit institution.
The objective of the discount without physical format is to serve the wide portfolio of clients that generate a massive billing of transactions to a company, in such a way that the large amount of administrative burden involved in handling that amount of physical receipts is eliminated.
As the drawing document is not generated, the assignor does not transfer the debt to the credit institution, but continues to keep it. For this reason, in this type of discounts what is produced is an advance on the transferor’s trade claims. Unlike the conventional discount, the risk for the credit institution is concentrated in the transferor.
Discountable instruments
According to the form of the claims assigned:
- Discount of enforceable instruments (bills, promissory notes or other negotiable instruments).
- Discount of ordinary claims (receipts).
- Debt acknowledgments such as work completion certificates (documents issued by public bodies or companies in charge of an activity).
Normally, the discount refers to claims incorporated into credit instruments or securities that confer on the holder the right to receive from the debtor a sum of money (payment instruments). Bills, promissory notes, or other negotiable instruments are typically discountable instruments. However, there is nothing to prevent ordinary claims from being discounted as well.
a. Negotiable receipts.
These are instruments with a significant growth in the discount area over the last few years. Most companies of a certain size have a mechanized system for the automatic issuance of negotiable receipts. These are later sent to the credit institution for their discount, which is in charge of liquidating their stamp tax according to their amount. Negotiable receipts maintain an apparently identical format to that of bills, although they are not accepted and lack enforcement action.
b. The bill of exchange.
The bill of exchange is a credit instrument that requires a certain amount of money to be paid at maturity, in a specified place, to the person first designated in the document, or, at the latter’s order, to a different person also designated.
c. The promissory note.
The promissory note is an instrument by which the person who issues it, called the signer, is obliged to pay another, called the holder, or to their order a certain amount on a certain date and place. Therefore, it is not, unlike the bill of exchange, a payment order or mandate given to a third party, but a promise of payment made by the signer, who is directly and personally bound.
d. The work completion certificates.
A work completion certificate is an acknowledgment of debt issued by a government or private entity in relation to payments pending to be made to suppliers for works or services.
The certificate discount allows companies in whose favour they are issued not to have to wait for payment. It is a somewhat different discount, since it is not a matter of discounting claims pending maturity, but claims already overdue whose payment is delayed.
Usually, the company endorses the certificate in favour of a credit institution, which presents it to the paying body so that it can “record” the endorsement. This “recording” makes it easier for the payment to be made directly to the institution that discounted the certificate.
The discount agreement
It is a commercial agreement generally of a standard-form nature. When credit instruments are discounted, they are transferred to the discounting credit institution.
The formalization of the merchant discount is carried out through the following documents:
- The bordereau or invoice that lists the instruments that are presented for discount in each remittance
- The settlement invoice for the instruments finally discounted.
- The merchant discount agreement, which is a document that regulates the conditions by which discount transactions will be governed and covers possible documents that are unpaid that cannot be debited, due to an insufficient balance, on the customer’s account.
Obligations of the credit institution
- To deliver the amount of the discounted claims in the agreed manner, normally by crediting the customer’s account.
- To diligently carry out the collection process. This means preventing the discounted instrument from being damaged. In the case of enforceable negotiable instruments (bill and promissory note), it implies the duty of presentation of the documents for collection or, where appropriate, the duty to make its protest, in due time and form, in case of non-payment. In the case of ordinary claims, to collect them on the due date and at the indicated payment place.
Obligations of the assignor
The obligations of the assignor are the following:
- To transfer the discounted claim to the discounting institution. It must be a complete disposal.
- To bear the cost of the discount, that is, the interests that the credit institution discounts directly, as well as the special expenses that the discount may cause (collection process, protest, etc.) and commissions. The interest rate can be fixed or adjustable depending on the term to maturity of the instrument, normally according to tranches per day (up to 30 days, between 30 and 60 days, between 60 and 90 days, etc.). The discounting commissions depend on the quality of the instrument (accepted or not, direct debited or not). The default commission is a percentage of the nominal amount of the instrument in the event that it is unpaid at maturity. There is a special rate called forfait in which the interest rate does not vary, regardless of the term to which the different instruments are discounted, and discounting commissions are not charged. The only amounts charged are the default commission and the expenses that the collecting credit institution may eventually pass.
- They will be liable for the existence and legitimacy of the assigned claims, as well as for the insolvency of the obligor if it were prior (and publicly known) to the discounting date.
- They must refund the amount of the discounted claims that are unpaid, in accordance with the clause “subject to collection “.
The risk in discount transactions
The risk of any discount transaction rests on the solvency of the obligor or drawee. As a differentiating feature, the default risk is placed on an individual or a company other than the company to which the financial institution grants the financing (assignor).
A special risk situation is generated when the assignor discounts instruments that do not have a commercial origin, but are drawn to get resources from the credit institution.
