Discounting is used in international finance when using short term financing options. The most popular type of short term financing is through the bank, with bank loans. Bank loans help companies in various ways. They are shown on the balance sheet because they tend to increase a company’s assets, inventory and accounts receivable accounts. Bank loans are known to be very liquid. Discounting is a form of bank credit, which is an option used frequently because they are flexible and expandable. When a company cant use trade credits they turn to the bank for help and use bank credit. One of the most popular forms of bank credits is discounting. Discounting can be seen used in many European countries and in Latin America.

Here are the typical transactions that take place when using discounting as a short-term financing option. For example, lets say a wholesaler is selling to a retailer on credit. The wholesaler and buyer have an agreement (bill) on payment terms, usually no more than 90 days to be considered short term. The buyer has to accept the terms and the bill and have their bank accept it. This is where the bank gets involved and makes their money off the discount. The wholesaler must take the bill of acceptance to their bank, in order to receive the funds from the buyer. At this point there is a negotiation at which a discount is formed for the bill being purchased by the bank. So the actual discounting, in this situation, takes place when the bill is sold to the wholesaler’s bank, in order to guarantee payment. The interest rates will vary from market to market or country-to-country, depending on how much is being bought/sold.

Another simple way to describe discounting is when a borrower borrows money at a discount, meaning some fee is taken off at the beginning, for example the interest rate. The interest rate can be unpaid in the initial purchase of a loan and also other financing charges, but the borrower must pay the full amount of the loan at the end of the terms.

Sources:

http://online.wsj.com/article/SB10001424052748704825504574585914030214796.html (www.wsj.com), www.businessfinance.com/discounting