Bill of Exchange: How it Works, Examples & All You Need

Bill of exchange

A bill of exchange is a written order that is used largely in international trade. This type of order binds one party to pay a specific sum of money to another party either on demand or at a predetermined date. In the same way that cheques and promissory notes can be written by either an individual or a bank, bills of exchange can typically be transferred from one party to another with the use of endorsements. What exactly does this mean? Let’s explore in detail with examples to help you understand all that bills of exchange entail.

Understanding a Bill of Exchange

There can be up to three parties involved in a bill of exchange transaction at once. The party that is responsible for making the payment stipulated under the bill of exchange is known as the drawee. The person who really gets the money is called the payee. The drawee is the one that is obligated to pay the payee; this party is known as the drawer. If the drawer does not transfer the bill of exchange to a different payee, then both the drawer and the payee are considered to be the same entity.

Hence, a bill of exchange is a written document that outlines a debtor’s indebtedness to a creditor. A check, on the other hand, is just a piece of paper. It is frequently employed as a method of payment in international commerce, whether for the exchange of products or services. Even though a bill of exchange is not in and of itself a contract, it can be used by the parties involved to fulfill the requirements of a contract. It is possible for it to stipulate that payment is required either immediately or at a particular time in the future. It is frequently made available with credit conditions, such as ninety days’ worth. In addition, for a bill of exchange to be considered valid, it needs to be acknowledged and accepted by the drawee.

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Since bills of exchange do not typically accrue interest, they are, in practice, the same thing as post-dated checks. However, if they are not paid by a specific date, they may begin to accumulate interest; in this instance, the rate must be indicated on the instrument. On the other hand, if they are transferred in advance of the date that is stipulated for payment, a reduction will be applied. In a bill of exchange, the amount of money, the date, and the persons involved, including the drawer and the drawee, must all be specified in a clear and concise manner.

When a bill of exchange is issued by a bank, it is sometimes referred to as a “bank draft” instead of just a “bill of exchange.” The bank that issued the currency guarantees that the transaction will be paid for. Bills of exchange that are issued by private parties are sometimes referred to as “trade drafts” instead of “bills of exchange.”

A sight draft is the type of bill of exchange that should be used when the funds are expected to be paid immediately or on demand. In the context of international commerce, an exporter has the ability to retain ownership of the items being exported through the use of a sight draft until the importer takes delivery of the products and immediately pays for them. On the other hand, if the money is scheduled to be paid at a particular period in the future, this type of draft is referred to as a time draft. The importer has a limited length of time after receiving the products to make payment to the exporter for the price of the goods via a time draft.

Transferability of a Bill of Exchange

Because a bill of exchange can be transferred from one party to another, the drawee may end up having to pay a completely different party than the one it had previously committed to pay. By endorsing the reverse of the paper, the payee has the ability to pay the bill on behalf of another person.

Discounting a Bill of Exchange

In order to get funds before the date of payment that is mentioned on the bill of exchange, the payee of the bill of exchange may sell the bill to another party for a price that is reduced from its face value. The discount represents the cost savings in interest that result from making the early payment.

When Interest is Included in a Bill of Exchange

In most cases, a bill of exchange will not necessitate the payment of interest on the outstanding balance. If there is an obligation to pay interest, the contract will specify the annual percentage rate of that interest. A bill that does not pay interest is, in effect, the same thing as a cheque with a post-dated due date.

Risks Associated with Bills of Exchange

When a company accepts a bill of exchange, it takes the risk that the drawee won’t pay for the goods or services. If the drawee is a person or a non-bank business, this is a particularly important consideration. Before agreeing to pay the bill, the payee is obligated to conduct research into the creditworthiness of the issuer, regardless of who the drawee is. A bill is considered dishonored when the person who is obligated to pay it fails to do so by the deadline specified on the bill.

Identifying Characteristics of Bills of Exchange

The following is a list of characteristics that bills of exchange have:

  • A written instrument is referred to as a “bill of exchange.”
  • The maker, often known as the drawer of the bill, is the one who actually draws and signs it.
  • It is expected that the particular person, referred to as the drawee, will pay the allotted sum.
  • It contains an order to a person, sometimes known as the drawee, that is not subject to any conditions.
  • It is necessary for the drawee to accept the instrument for it to have any value.
  • The amount that has been set is to be paid either to the person whose name is listed on the bill, to his order, or to the person who is in possession of the bill.
  • It outlines the deadline by which the specified sum must be paid.
  • The amount owed must be paid in the country’s official currency in order to settle the account.
  • It is required to have the appropriate stamps.
  • A tax stamp is required to be affixed to it.

Bill of Exchange Examples

Let’s say that Car Supply GHI sells auto parts to Company ABC for the price of $25,000. In this scenario, Car Supply GHI acts both as the drawer and the payee on a bill of exchange that it creates.

According to the bill of exchange, Company ABC is obligated to pay Car Supply GHI the sum of $25,000 within ninety days. Company ABC takes on the role of the drawee, receives the bill of exchange, and then arranges for the shipment of the goods. Within the next ninety days, Car Supply GHI will give the bill of exchange to Company ABC in order to receive payment for it. Car Supply GHI, which was also the creditor in this scenario, drew up the bill of exchange as an acknowledgment to demonstrate that Company ABC, which was in the position of being the debtor, owed money to them.

What Are Some Differences Between a Bill of Exchange and a Check?

When you write a check, you are always dealing with a bank, but a bill of exchange could involve anyone, including a bank. Payable on demand is the standard operating procedure for checks, but a bill of exchange might indicate that payment is due either immediately or at a future date. Since bills of exchange do not typically accrue interest, they are, in practice, the same thing as post-dated checks. If they are not paid by a specific date, they may begin to accrue interest; however, the rate at which the interest is accrued must be indicated on the instrument. A bill of exchange is a written document that outlines a debtor’s indebtedness to a creditor. A check, on the other hand, is just a piece of paper.

Who Are the People Who Are Listed on a Bill of Exchange?

As earlier mentioned, there can be up to three parties involved in a bill of exchange transaction at once. The party that is responsible for making the payment stipulated under the bill of exchange is known as the drawee. The person who really gets the money is called the payee. The drawee is the one that is obligated to pay the payee; this party is known as the drawer. If the drawer does not transfer the bill of exchange to a different payee, then both the drawer and the payee are considered to be the same entity.

What Are the Different Types of Bills of Exchange?

The term “bank draft” refers to a bill of exchange that has been issued by a financial institution. The bank that issued the currency guarantees that the transaction will be paid for. A trade draft is a term that is used to refer to a bill of exchange that has been issued by an individual. A sight draft is the type of bill of exchange that should be used when the funds are expected to be paid immediately or on demand.

In the context of international commerce, an exporter has the ability to retain ownership of the items being exported through the use of a sight draft until the importer takes delivery of the products and immediately pays for them. However, if the funds are scheduled to be paid at a specific date in the future, this type of draft is known as a time draft. This type of draft provides the importer with a limited amount of time after receiving the products to pay the exporter for the commodities.

What’s the Difference Between a Promissory Note and a Bill of Exchange?

A bill of exchange is different from a promissory note since it can bind one party to pay a third party who was not involved in its production. Additionally, a bill of exchange can be transferred, but a promissory note cannot. Promissory notes, in the form of banknotes, are extremely prevalent. A bill of exchange is a document that is issued by a creditor to a debtor that commands the debtor to pay a specified sum within a specified amount of time. The promissory note, on the other hand, is a commitment made by the debtor to pay a certain sum of money within a specified time period. The debtor is the one who issues the promissory note.

The Meaning of the term “Promissory Note”

A promissory note is a written instrument (that is not a banknote or a currency note) that contains an unconditional undertaking signed by the maker to pay a certain sum of money only to or to the order of a certain person, or to the bearer of the instrument. The promissory note is defined as an instrument in writing (that is not a banknote or a currency note).

Importance of Promissory note in Bill of Exchange

The word “promissory note” comes from the Negotiable Instruments Act of 1881, which defines it as “an instrument in writing (not being a banknote or a currency note), containing an unconditional undertaking signed by the maker, to pay a certain sum of money only to or to the order of a certain person, or to the bearer of the instrument.” This definition applies to any written document that is not a banknote or a currency note. On the other hand, a promissory note that is payable to the bearer is against the law, as stated by the Reserve Bank of India Act. Because of this, a promissory note can never be written so that it is payable to the bearer.

Bills of Exchange FAQs

What is bill of exchange with example?

A bill of exchange is useful if it is accepted by the person to whom it is addressed. For instance, if A orders Y to pay $50,000 within 90 days of the date, and B accepts this order by signing his name, then this is a bill of trade.

Is cheque a bill of exchange?

No, a cheque is totally different from a Bill of exchange.

Who is drawer and drawee?

The maker of a bill of exchange or a check is referred to as the “drawer,” while the recipient is known as the “drawee.”

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