Bill of Exchange Definition: Examples and How It Works
A bill of exchange is a written order used primarily in international trade that binds one party to pay a fixed sum of money to another party on demand or at a predetermined date. Bills of exchange are similar to checks and promissory notes—individuals or banks can draw them and are generally transferable by endorsements.
Understanding Bills of Exchange
A bill-of-exchange transaction can involve up to three parties. The drawee is the party that pays the sum specified by the bill of exchange. The payee is the one who receives that sum. The drawer is the party that obliges the drawee to pay the payee. The drawer and the payee are the same entity, unless the drawer transfers the bill of exchange to a third-party payee.
Unlike a check, a bill of exchange is a written document outlining a debtor’s indebtedness to a creditor. It’s frequently used in international trade to pay for goods or services. While a bill of exchange is not a contract, the involved parties can use it and the attached forms to fulfill the contract terms. It can specify that payment is due on demand or at a specified future date. It’s often extended with credit terms, such as 90 days. Also, the drawee must accept a bill of exchange to be valid.
Bills of exchange generally do not pay interest, making them, in essence, post-dated checks. They may accrue interest if not paid by a specific date, but the instrument must specify the rate. They can, conversely, be transferred at a discount before the date specified for payment. A bill of exchange must detail the amount of money, the date, and the parties involved, including the drawer and drawee.
If a bank issues a bill of exchange, it can be referred to as a bank draft. The issuing bank guarantees payment on the transaction. If individuals issue bills of exchange, they can be referred to as trade drafts. If the funds are to be paid immediately or on demand, the bill of exchange is known as a sight draft. In international trade, a sight draft allows an exporter to hold title to the exported goods until the importer takes delivery and immediately pays for them. However, if the funds are to be paid at a set date in the future, it is known as a time draft. A time draft gives the importer a short amount of time to pay the exporter for the goods after receiving them.
The difference between a promissory note and a bill of exchange is that the latter is transferable and can bind one party to pay a third party not involved in its creation. Banknotes are common forms of promissory notes. The creditor issues a bill of exchange and orders the debtor to pay a particular amount within a given period. On the other hand, the debtor issues the promissory note, which is a promise to pay a specific sum of money over a specific time period.
Example of Bill of Exchange
Say Company ABC purchases auto parts from Car Supply XYZ for $25,000. Car Supply XYZ draws a bill of exchange, becoming the drawer and payee in this case. The bill of exchange stipulates that Company ABC will pay Car Supply XYZ $25,000 in 90 days. Company ABC becomes the drawee and accepts the bill of exchange, and the goods are shipped. In 90 days, Car Supply XYZ will present the bill of exchange to Company ABC for payment. Car Supply XYZ, who was also the creditor in this case, created the bill of exchange to demonstrate the debt of Company ABC, the debtor.
What Are Some Differences Between a Bill of Exchange and a Check?
A check always involves a bank, while a bill of exchange can involve anyone, including a bank. Checks are payable on demand, while a bill of exchange can specify that payment is due on demand or at a specified future date. Bills of exchange generally do not pay interest, making them post-dated checks. They may accrue interest if not paid by a specific date, but the instrument must specify that rate. Unlike a check, a bill of exchange is a written document outlining a debtor’s indebtedness to a creditor.
Who are the parties to a bill of exchange?
A bill-of-exchange transaction can involve up to three parties. The drawee is the party that pays the sum specified by the bill of exchange. The payee is the one who receives that sum. The drawer is the party that obliges the drawee to pay the payee. The drawer and the payee are the same entity, unless the drawer transfers the bill of exchange to a third-party payee.
What Are the Different Types of Bills of Exchange?
A bill of exchange issued by a bank is referred to as a bank draft. The issuing bank guarantees payment on the transaction. A trade draft is a bill of exchange that an individual issues. If the funds are to be paid immediately or on demand, the bill of exchange is known as a sight draft. In international trade, a sight draft allows an exporter to hold title to the exported goods until the importer takes delivery and immediately pays for them. However, if the funds are to be paid at a set date in the future, it is known as a time draft, which gives the importer a short amount of time to pay the exporter for the goods after receiving them.
What’s the Difference Between a Bill of Exchange and a Promissory Note?
The difference between a promissory note and a bill of exchange is that the latter is transferable and can bind one party to pay a third party not involved in its creation. Banknotes are common forms of promissory notes. The creditor issues a bill of exchange and orders the debtor to pay a particular amount within a given period. On the other hand, the debtor issues the promissory note and promises to pay a specific amount of money in a given period.
Conclusion
- A bill of exchange is a written order binding one party to pay a fixed sum of money to another party on demand or at some point in the future.
- A bill of exchange often includes three parties—the drawee is the party that pays the sum, the payee receives that sum, and the drawer is the one that obliges the drawee to pay the payee.
- A bill of exchange is used in international trade to help importers and exporters fulfill transactions.
- While a bill of exchange is not a contract itself, the involved parties can use it to specify the terms of a transaction, such as the credit terms and the rate of accrued interest.
