What Is a Bill of Exchange?
A bill of exchange is a written order commonly used in international trade. It legally binds one party to pay a fixed sum of money to another party either on demand or at a specified future date. Similar to checks and promissory notes, bills of exchange can be issued by individuals or banks and are transferable through endorsements.
### Key Takeaways:
– A bill of exchange obligates one party to pay a fixed sum of money to another party.
– It involves three key parties: the drawee (pays), the payee (receives), and the drawer (initiates payment).
– Widely used in international trade to facilitate transactions.
– While not a contract, parties can use it to specify transaction terms such as credit terms and interest rates.
Source: Investopedia / Laura Porter
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Understanding Bills of Exchange
A bill of exchange involves three main parties: the drawee (pays), the payee (receives), and the drawer (initiates payment). Unlike a check, a bill of exchange signifies a debtor’s obligation to a creditor. Typically used in international trade, it can outline payment terms and specify payment dates, known as the usance period. For the bill to be valid, it must be accepted by the drawee.
Bills of exchange usually do not accrue interest like post-dated checks, but interest may apply if payment is delayed beyond a specified date. They can also be transferred at a discount prior to the due date. Proper documentation of amount, date, and involved parties is crucial for a bill of exchange.
In international trade, bills of exchange can be referred to as bank drafts when issued by banks, guaranteeing payment. For individual issuers, they are known as trade drafts. A sight draft demands immediate payment upon delivery, while a time draft allows a grace period for payment in the future, benefiting importers and exporters handling transactions.
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Example of Bill of Exchange
For instance, suppose Company ABC purchases auto parts from Car Supply XYZ for $25,000. Car Supply XYZ issues a bill of exchange, making them the drawer and payee. Company ABC, as the drawee, accepts the bill and the goods are shipped. After 90 days, Car Supply XYZ will request payment from Company ABC as per the bill of exchange, representing the indebtedness of Company ABC to Car Supply XYZ.
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Differences Between a Bill of Exchange and a Check
A bill of exchange can involve various parties and payment terms, unlike a check that typically involves a bank and immediate payment. While bills of exchange do not usually accrue interest, they can do so after a specified period if not paid on time. Unlike a check, a bill of exchange signifies a debtor’s indebtedness to a creditor.
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Parties to a Bill of Exchange
In a bill of exchange transaction, three parties are typically involved – the drawee (pays), the payee (receives), and the drawer (initiates payment). The drawer and payee are often the same, barring any transfers to third-party payees.
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Different Types of Bills of Exchange
A bill of exchange issued by a bank is termed a bank draft, assuring payment. Individual issuances are trade drafts. Sight drafts demand immediate payment, while time drafts provide a brief window for future payment in international trade transactions.
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Difference Between Bill of Exchange and Promissory Note
Unlike promissory notes, bills of exchange are transferable and can bind unrelated parties to payment. Banknotes often act as promissory notes, unlike bills of exchange issued by creditors to debtors. The latter specifies payment obligations, whereas a promissory note is a debtor’s promise to pay within a given timeframe.