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A Guide to the Use of Cheque Discounting as a Robust Trade Finance Solution

Table of Contents

Introduction

Managing cash flow and working capital is very important for businesses. It allows companies to pay their bills on time. It also lets them buy inventory, meet payroll, and expand. However, it can sometimes be difficult for businesses to access cash quickly. Cheque discounting helps address this challenge.

Cheque discounting lets businesses get money from their bank. They get it before a customer’s cheque has cleared. This provides immediate access to funds which can then be used to manage cash flow needs. In this blog, we will explain what cheque discounting is. We will cover who qualifies, how it works, and its benefits.

What is Cheque Discounting?

Cheque discounting lets businesses get cash before a customer’s cheque clears. When a customer pays by cheque, it usually takes 3-5 business days for the cheque to clear. Then, the funds become available in the company’s bank account.

Through cheque discounting, businesses can deposit the cheques they receive with their bank. In return, they get immediate access to cash. The bank provides a percentage of the cheque amount upfront, usually 70-80%. Then, it collects the full value when the cheque clears. This bridges the time gap and improves cash flow.

Who Qualifies for Cheque Discounting in UAE?

To use cheque discounting, companies must meet the basic eligibility criteria set by banks:

  • Registered in the UAE with a valid trade license for at least 6 months
  • Maintain a good credit history and timely repayment of existing loans
  • Provide latest financial statements like balance sheet and income statement
  • Only accept cheques from reputed established companies or government bodies
  • Personal or related party cheques may not be accepted
  • Sufficient collateral may be required against large discounted amounts

Banks thoroughly review these aspects before approving a cheque discounting facility.

How Does the Process Work?

Here are the typical steps involved in availing cheque discounting:

  • Apply to bank by submitting application form along with required documents.
  • Bank evaluates application basis credit history and financial position.
  • Post approval, submit post-dated cheques issued by customers.
  • Bank discounts a percentage of each cheque value and credits the amount.
  • On due date, bank deposits cheque for collection and deducts principal plus interest.
  • Renew or settle facility by repaying full amount if cheques are honoured.

Let’s understand this process in more detail:

Key Terms and Conditions

Business owners must clearly understand the cheque discounting terms set by banks:

  • Interest rates typically range between 4-6% annually
  • Processing fees of 1-2% of discounted amount are common
  • Cheques must be deposited for collection within 60-90 days
  • Late repayment is subject to penalty interest
  • 100% cash margin may be required against large amounts
  • Post-dated cheques can be submitted in case of defaults
  • Banks have different policies, so comparing rates across multiple banks is recommended.

Benefits of Cheque Discounting

When used judiciously, cheque discounting provides meaningful benefits to businesses:

  • Improves liquidity and helps manage cash flows better
  • Access cash immediately without waiting for clearance
  • Aids quick payments to suppliers and other expenses
  • Supports short-term working capital requirements
  • Flexible tenure renewal allows planning investments
  • Strengthens supplier relationships through timely payments

Potential Risks Involved

However, a few risks need consideration when using this facility:

  • Exposure if customer cheque is dishonoured on maturity
  • Interest costs on the amount taken until clearance of cheque
  • Economic downturns may increase rate of bounced cheques
  • Requirement to provide collateral raises default risk
  • Penalties for delayed payment or pre-closure of facility
  • Taxes on interest income in case of Corporate clients

Conclusion

In summary, cheque discounting is a useful short-term financing product. It lets businesses improve liquidity and manage working capital needs. It carries risks. But, it is an affordable alternative to other loans. That’s if used carefully and considering all guidelines. Business owners must thoroughly analyze their cash flow cycles. They must also look at their liability. They do this to decide if this facility is suitable.

You should ask experienced financial advisors for help. They can help you find banks in the UAE that offer competitive cheque discounting. These solutions are tailored to the needs of individual businesses. Good research and following the terms can maximize the benefits. They are key for this trade finance tool.

FAQs

Q. How do I know the latest cheque discounting rates?

A: Contact 3-5 major banks that provide this facility. Rates may vary slightly so it’s wise to compare options.

Q. What if the discounted cheque gets bounced?

A: You will need to immediately return the amount taken along with penalty interest to the bank. It may affect future access too.

Q. Is pre-payment or early closure allowed?

A: Most banks allow pre-payment but charge a small fee (1-2% of outstanding amount) for this. Check terms in advance

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VIBHA MALIK MODI

Ms. Vibha Modi, CA, is supported by 13+ Years of Corporate Tax, International Taxation and Accounting Expertise.

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