What is Bills of Exchange?
Bills of Exchange are documents in writing signed by the maker, promising timely payment for the products bought or used. The payment could be made either on demand or within a predetermined period as specified in the bill. The credential holds significance in facilitating international trade, where it is used as an effective mode of settling payments.
Acting like a promissory note, the bills of exchange make the parties stick to the payment clauses at any cost. It involves a drawee, a drawer, and a payee, and is used when the goods and products are purchased with the payments being deferred to a future date, which may be a date on which sellers demand it or any predetermined future date.
Table of contents
- Bills of exchange are negotiable instruments that contain an order to pay a certain amount to a particular person or entity within a stipulated period.
- It is issued by the creditor to the debtor when the latter owes money for goods or services.
- If the debtor fails to pay the amount within a specific period mentioned in the bill of exchange, the bill is said to be dishonored.
- Trade bills, sight drafts, bank drafts, and time bills are the common types of bills of exchange.
Bills of Exchange Explained
Bills of Exchange are written documents that the makers draft to ensure the payments for the purchased goods are made on time. The buyer prepares this document to assure sellers of the timely payment. They either promise to pay on demand or on any date on which both parties agree. In short, they act similar to a post-dated check. Multiple clauses are jotted down in the document, which the parties involved need to follow.
The parties involved in honoring the bill of exchange are – the drawee, drawer, and payee. A former is the one that issues the document and promises to pay on time, while a payeePayeeA payee refers to a person, business, government, or any other entity that receives payment for providing goods or services. is a party that receives the payment made by the former. A drawer, on the contrary, becomes a link between the payor and the payee, obliging the former to pay the latter on the predetermined future date or an and when demanded. A drawer, however, must accept the payment made by the drawee for the bill of exchange to be valid.
This document is an obligation, which, if not honored, could lead to the issuance of a formal notice, indicating the failure to obey the clauses. In addition, unlike promissory notes, bills of exchange are transferable. This means the payee might change if the original recipient transfers the document to it. Therefore, the drawee ends up paying someone else, not the one that it originally issues the bill to.
The types help us understand the meaning of bills of exchange in depth. This is because the classification lets one know the purpose for which these drafts or bills are used.
When a bank issues these written documents, it becomes a bank draft, while if individuals issue the same to settle a trade, these are termed trade drafts. On the contrary, if these written documents are issued to assure on-demand payments, they are referred to as a sight draft. Lastly, when these drafts are prepared as a guarantee of payment at a future predetermined date, it is known as a time bill or draft.
The features that make the bills of exchange an easily identifiable note promising payments are as follows:
- It is a written document, and no verbal commitment is valid.
- It acts as an order for debtorDebtorA debtor is a borrower who is liable to pay a certain sum to a credit supplier such as a bank, credit card company or goods supplier. The borrower could be an individual like a home loan seeker or a corporate body borrowing funds for business expansion. to pay the amount in time and has no other condition included in it.
- The document clearly mentions the amount that needs to be paid and the date within which the payment is to be done.
- Lastly, after articulating every detail on the bill, the party that issues it must sign it before sending it to the other party.
Format of Bills of Exchange
Though the bills of exchange format differ from one issuer to another, a few details are necessarily present in them. These include the following:
- The title bills of exchange is on the cover page of the document or top of the page, or wherever it starts.
- The amount that the maker has to pay to the other party. It is expressed both in digits and in words.
- The date on which the sum is to be paid. It is mentioned under As of.
- The payee is the section that contains the name of the recipient.
- The identification number is unique for every bill.
- A signature contains the sign of the maker or drawer who obliges the drawee to pay the payee.
Let us consider the following bills of exchange examples to understand the concept better:
Let’s say Samuel issues a bill of exchange for Marco, who purchases goods for $100,000 from him. The bill was issued on 05.10.2020. It is the same date when the goods are purchased on credit. But Marco doesn’t accept the bill on the same date. Instead, he accepts it on 10.10.2020.
In this situation, Samuel issues the bill and becomes the creditor to Marco. On the other hand, the latter is a debtor who has purchased goods from the former on credit. However, the document did not become the bill of exchange until it was finally accepted on the 10th of October. This is how it works.
Company ABV issued a bill for Company BVX, which purchased goods worth $20,000 on credit. ABV writes, “Three months after the date, pay us a sum of twenty thousand dollars.” BVX accepts the bill. However, it doesn’t pay the due amount on the due date.
In this case, ABV’s bill gets dishonored. Hence, all parties here receive a notice specifying that the bill has been dishonored.
Advantages & Disadvantages
Bills of exchange guarantee payment from one party to another at a specified date. However, along with the document’s list of uses and benefits, certain cons also need consideration. Therefore, let us have a quick look at its advantages and disadvantages:
|A valid legal document, promising payment within a specified date.||Risk of dishonor|
|Easy to transfer||Only fit for short-term services|
|Drafted after mutual consent||Drawee faces an additional burden when discounting.|
|Effective mode of credit in international trade|
Frequently Asked Questions (FAQs)
A payee might sell this draft or bill to some other party at a discounted rate to get paid before the predetermined date. This is called the discounting of bills of exchange. This discounted sum is the interest cost that the original payees receive early. However, it increases the burden of the drawee as they have another payee to deal with.
Yes, bills of exchange are used widely, especially in international trade. It provides a guarantee to sellers of receiving the payment either on demand or at a future predetermined date. This document is useful for all parties involved as it gives payors sufficient time to pay for the items bought and payees a guarantee to receive the payment as promised.
The due date can be found in the As of section of the document. It is calculated based on the receipt of the bills of exchange. For example, if the issue date of the document is 1st January 2022, and the payment is due after 30 days, the due date would be calculated as:
30 days of January + 3 days of grace (normally considered) = Feb 3, 2022.
The calculation above excludes the date of receipt of the document but includes the date of payment.
This has been a guide to what are the Bills of Exchange. Here, we explain its types, format, examples, characteristics, advantages, and disadvantages. You may also have a look at the following recommended articles on fixed income –