Generally, when trading internationally, one significant risk businesses face is associated with payments.
Companies think of selling goods and services on credit to boost their business, but the high possibility of non-payment holds them back.
To combat this issue and allow exporters to sell their goods, the use of negotiable instruments came into use.
These instruments act as an assurance to the seller that the payment, if sold on credit, will be paid when due. One such negotiable instrument is a bill of exchange.
Meaning of Bill of Exchange
A bill of exchange is a document or a legally binding agreement negotiable instrument binding one party (buyer) to pay a fixed amount on demand or at a predetermined date to another party.
This instrument is mainly used in international trading to mitigate the risk of non-payment.
A bill of exchange can either be drawn by banks or individuals, which are transferable through endorsements.
Importance of Bill of Exchange
The importance of a bill of exchange is usually used in international trade.
It allows sellers and buyers to mitigate risks related to different currencies, legal jurisdictions, and fluctuations in exchange rates.
Information on a Bill of Exchange
A bill of exchange should contain the following information:
- Title : The term “bill of exchange” needs to be mentioned on the face of the document.
- Amount : The amount required to be paid must be clearly stated in text and numerically.
- ‘As of’ or Date : This field needs to mention the timeline for the amount to be paid. It can be based on a predetermined date, shipment, delivery, etc.
- Payee :This includes the party’s name and maybe address to be compensated or paid.
- Identification Number : Every bill of exchange should have its unique ID.
- Signature : Finally, it needs the signature of an authorised representative to bind the buyer or drawee to pay the designated amount to the drawer.
Party Issuing Bill of Exchange
A bill of exchange is issued by the creditor or beneficiary who orders the debtor or buyer to pay a fixed sum of money within a specified time period.
Parties to a Bill of Exchange
There are three parties involved in the execution of the bill of exchange. These are:
1. Drawer
The drawer is the party that writes or authorises the bill of exchange and orders the amount to be paid.
2. Drawee
This is the party or individual ordered or required to pay the amount mentioned in the bill.
3. Payee
A payee is a beneficiary of the bill of exchange. Payee receives the money owed by the drawee.
(Note - The drawer and the payee can be the same entity unless the drawer transfers the bill of exchange to a third-party making them the payee.)
Types of Bills of Exchange
There are various bills of exchange used by traders, such as:
1. Inland Bill
An inland bill of exchange is when the bill is drawn and paid in the same country. For example, a bill of exchange drawn in India will also be paid in India.
2. Demand Bill
A bill of exchange that must be paid on demand is called a demand bill. It has no specified date or time on when it will be paid. The payment can be made as and when the bill is presented.
3. Foreign Bill
A foreign bill is when a bill of exchange is issued and paid outside India’s territory. Different rules and regulations back these bills compared to other bills. There are two types of foreign bills:
- Export Bill - A bill of exchange drawn by an exporter for a party outside Indian waters.
- Import Bill - A bill of exchange drawn by an exporter outside India for Indian importers.
4. Usance Bill
An usance bill of exchange specifies the time period within which the credit purchase payment is to be made to the seller by the buyer. It is called a time-bound bill.
5. Clean Bill
A bill of exchange without document proof is called a clean bill. These bills levy a higher interest rate than other documented bills since no documents are involved in issuing them.
6. Documentary Bill of Exchange
A bill supported by all necessary and relevant documents to verify the genuineness of the trade transaction taking place is called a documentary bill of exchange.
It helps to confirm the trade transaction between the exporter and importer. A document bill of exchange includes:
- Documents against acceptance bills (D/A) - Here, the documents are provided in exchange for accepting the bill of exchange.
- Documents against payment bills (D/P) - Here, the documents are given in exchange for payment of the bill of exchange.
7. Accommodation Bill
A situation where no trade transaction of goods or services takes place but is used as an agreement between the two parties to give each other financial assistance is called an accommodation bill. This bill allows a party involved to raise finance in credit without making any transaction or consideration.
8. Trade Bill
A bill of exchange drawn for the intention of settling a credit trade transaction and is then accepted is known as a trade bill.
It generally takes place between a buyer and seller to allow the buyer to make a credit purchase.
9. Supply Bill
When goods are supplied to any governmental bodies by a contractor or supplier and a bill is drawn, it is called a supply bill of exchange.
Functions of Bill of Exchange
A bill of exchange is issued because it performs certain functions, such as:
1. Performs as a Mean of Payment In international trade, a bill of exchange is used as a mode of payment. It helps to protect international trade agreements that are volatile to exchange rate fluctuations and provides assurance of payment to the holders of a fixed sum of money.
2. Acts as a Mean of Funding A bill of exchange is also used as a way of getting funds. If a bill specifies the payment to be made on a future date, then the bill can be discounted, and the drawer can sell the bill to a third-party institution (generally a bank) in exchange for quick payment.
The amount then will be received by the bank by the drawee after the maturity period of the bill.
3. Acts as Evidence A bill of exchange is also helpful in showing proof or evidence of a transaction that has taken place.
It can be used as evidence of payment which is owed by the buyer or drawee to the payee.
Working of Bill of Exchange
A bill of exchange is a written document or a negotiable instrument that binds a party to another to make payment after a trade has taken place.
It is generally used in international trade when goods and services transactions take place on credit.
A drawer issues a draft, and when it gets accepted by the drawee, it becomes a bill of exchange. If a bank issues the bill of exchange, then the bill will be called a bank draft.
However, if it is issued by an individual, then it will be considered a trade draft.
A bill of exchange allows the avoidance of any risks associated with non-payment and other challenges hindering the transaction.
Example of Bill of Exchange
Suppose Akash Ltd. purchases auto parts from Ronald Car Supply Ltd. for $750,000. Ronald Car Supply Ltd. draws a bill of exchange (foreign bill), becoming the drawer and payee (in this case). The bill of exchange indicates that Akash Ltd. will pay Ronald Car Supply Ltd. $750,000 in 60 days.
Akash Ltd. becomes the drawee and accepts the bill of exchange for the goods to be delivered. In 60 days, Ronald Car Supply Ltd. will present the bill of exchange to Akash Ltd. for payment. The bill of exchange is an acknowledgment created by Ronald Car Supply Ltd., the drawer or payee, to show the amount owed by Akash Ltd., the drawee.
Advantages of Bill of Exchange
Here are a few reasons as to what makes bills of exchange a convenient instrument for credit transactions.
Legally Binding A bill of exchange is a legally accepted document that binds the parties involved in a legal relationship. Therefore, in case of payment disputes or any other complications between the parties, a bill of exchange can be used as concrete evidence before a court of law.
Widely Accepted A bill of exchange is generally used for international trading. It helps exporters grow their market by selling goods and services on credit and allowing foreign importers to pay later. This benefits both the exporter and the importer.
Easily Transferable A bill of exchange can be transferred to another party in case the drawer of the bill requires immediate payment.
The transferability can occur by the drawer selling the bill of exchange to a third party (generally a bank) at a discount, making the bank the payee, and ordering the drawee to make the payment to the bank (payee).
Difference Between a Bill of Exchange and a Promissory Note
A bill of exchange is issued by the drawer or seller of goods and services, ordering the debtor or buyer to pay a fixed sum of money at a future specified date.
A promissory note on the hand is issued by the debtor or buyer of goods and services, promising to make payment at a future date specified.
FAQs on Bill of Exchange
Is an Invoice a Bill of Exchange?
A bill of exchange includes information on what is being shipped and its quantity. It also describes the amount to be paid and when it is due, making it a type of invoice.
Who Can Accept a Bill of Exchange?
A bill of exchange is drawn or drafted by the creditor or seller of goods and services. It is accepted by the drawee or anyone on its behalf. A bill of exchange is considered a draft till the drawee accepts it.
Is a Bill of Exchange An Asset Or Liability?
The party or individual who accepts the bill of exchange (drawee or buyer) is a bill payable in their account, making it a liability for them as they have to pay the amount. The party who issues or draws a bill of exchange (drawer or payee or seller) is a bill receivable in their accounts, making it an asset for them.
