Bill of Exchange

A bill of exchange is a written order to an individual or financial institution to pay an amount of money to a third party on a specified date. It is considered safe because it is unconditional, reducing the chances of missed payments.

What Is a Bill of Exchange?

A bill of exchange is a debt instrument used by creditors to obligate the payment of money owed. Although not a contract in the traditional sense, it is legally binding, and a breach can result in legal battles.

Bills of exchange are useful in international trade, where a considerable period may pass between the release of goods and the payment. The payee presents it to the drawee to receive the payment.

Bills of exchange can be known by several names, including:

• International bill of exchange
• Bank note
• Draft
• Order of payment

Knowing when and how to use a bill of exchange can prove highly useful if you are required to pay or create a legal document like this.

Key characteristics of a bill of exchange

The table summarizes the most important aspects of a bill of exchange that make it a secure credit payment method.

Parties involved with a bill of exchange

There are three main bill of exchange parties involved in the creation and use of the document:

• Drawer: This is the person who creates and issues the bill. They do so to initiate payment to themselves or another party (payee). The drawer is often the seller in a trade setting.
• Drawee: The person or entity who is obligated to pay the money to the payee.
• Payee: The party that receives the money owed. In a trade setting, this is usually the drawer, but they can also direct that the money be paid to a different party.

The drawee must accept the bill of exchange by signing it to make it valid.

How Bill of Exchange Documents Are Used

Bills of exchange facilitate payments for goods and services. They are a credit tool used to guarantee payment on demand or on a future date. A bill of exchange is used for the following:

Securing transactions

Bills of exchange create a secure, legally binding, and unconditional order to pay money owed. The payee is guaranteed that they will receive their money.

In trade finance

Bills of exchange make international trade possible by providing a secure way for future payments. They eliminate the risks of losing money through defaulted payments or fluctuating foreign exchange rates.

Short-term credit

Instead of waiting weeks or months to get paid, a seller can take the bill to a bank and trade it in for cash right away. The bank takes a small fee, but this helps businesses keep money flowing.

Flexibility in business

Businesses thrive when there is assurance of payment and improved cash flow. Because bills of exchange are negotiable, they are transferable and can be used to pay other third parties.

What Information is Included in a Bill of Exchange?

Some preparation is necessary to create a bill of exchange. For example, you must know who the drawee is for the document to work.

You will need the following information to write a bill of exchange:

• Amount to be paid
• Due date on which payment must be made
• Name and information of the payee
• Payment method
• Drawee’s signature
• Your (the drawer’s) signature
• Date of issue
• Unique identifying number/reference number

Remember that bills of exchange are legally binding documents, so every entry should be accurate.

Types of Bill of Exchange

There are many kinds of bills of exchange. The name varies depending on who has issued it and why. They are also classified based on the terms of payment, whether they have other documents, and whether they are foreign or domestic.

The following are types of bills of exchange:

• Bank Draft: Issued by a bank
• Trade Draft: Issued by an individual
• Sight Draft: To be paid on demand
• Time Draft: To be paid on a set date
• Clean Draft: Not accompanied by shipping documents
• Documentary Draft: Has shipping and other trade documents attached to it
• Foreign bill/draft: Drawn in one country but payable in another

You may also encounter bills of exchange classified based on their purpose, such as an accommodation bill of exchange.

Bill of Exchange Vs. Promissory Notes and Checks

There are many similarities between bills of exchange, promissory notes, and checks. They are all debt instruments obligating a debtor to pay the creditor. However, there are also some very significant differences.

First and foremost, bills of exchange do not typically charge the drawee interest. However, interest is sometimes added to the amount payable if it is not paid within a certain timeframe.

Promissory notes, on the other hand, usually have interest payments written into their terms. You can include specific terms in your document if you use a flexible, customizable promissory note template.

Additionally, promissory notes cannot be exchanged or transferred. However, bills of exchange can be adjusted and paid by a different entity to the original drawee.

A check is a type of bill of exchange, but it works differently. Checks are typically drawn on a bank with no grace periods and no requirement for drawee bank acceptance.

Also, the drawer cannot cancel a bill of exchange, but a check can be cancelled at any time. While there are no special bill of exchange forms, checks must be written on a special form provided by the bank.