Bills of Exchange

Updated on January 5, 2024
Article byWallstreetmojo Team
Edited byAshish Kumar Srivastav
Reviewed byDheeraj Vaidya, CFA, FRM

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.

What Are Bills Of Exchange

You are free to use this image on your website, templates, etc, Please provide us with an attribution linkHow to Provide Attribution?Article Link to be Hyperlinked
For eg:
Source: Bills of Exchange (wallstreetmojo.com)

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.

Key Takeaways

  • 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.read more 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.

Bills Of Exchange Parties

You are free to use this image on your website, templates, etc, Please provide us with an attribution linkHow to Provide Attribution?Article Link to be Hyperlinked
For eg:
Source: Bills of Exchange (wallstreetmojo.com)

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.

Fixed Income Course (5+ Hours Video Series)

–>> If you want to Master Fixed Income, then you can consider our course on “Fixed Income: Valuation, Return and Risk Measures” provides a comprehensive overview of bond valuation, return metrics, and risk management within fixed income securities. The learners will gain required skills for analyzing bond characteristics, calculating yield measures, and implementing risk mitigation strategies, equipping them for success in navigating the intricacies of bond markets.

Types

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.

Bills Of Exchange Types

You are free to use this image on your website, templates, etc, Please provide us with an attribution linkHow to Provide Attribution?Article Link to be Hyperlinked
For eg:
Source: Bills of Exchange (wallstreetmojo.com)

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.

Characteristics

The features that make the bills of exchange an easily identifiable note promising payments are as follows:

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.

Examples

Let us consider the following bills of exchange examples to understand the concept better:

Example #1

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.

Example #2

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:

ProsCons
A valid legal document, promising payment within a specified date.Risk of dishonor
Easy to transferOnly fit for short-term services
Drafted after mutual consentDrawee faces an additional burden when discounting.
Effective mode of credit in international trade 

Frequently Asked Questions (FAQs)

What is discounting of bills of exchange?

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.

Are bills of exchange still used?

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.

How to find the due date in bills of exchange?

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 –

Reader Interactions

Leave a Reply

Your email address will not be published. Required fields are marked *