Bills of Exchange Features, Types and Uses

You might have heard about Bills of Exchange. Here, we’ve taken out time to discuss what Bill of Exchange is to all interested individuals and scholars.

What is Bills of Exchange?

A bill of exchange is an order to pay. It is typified by a cheque. There are usually three parties involved in a Bill of Exchange or a draft.

These are:- the drawer who orders the payment, the drawee who is ordered to pay and the payee, to whom payment is to be made. A Bill of Exchange is defined as:-

“An unconditional order in writing addressed by one person to another, signed by the person giving it, requiring the person to whom it is addressed to pay on demand, or at a fixed or determinable future date, a sum certain in money to order or to bearer.

Note also that there can be two parties in a draft I.e. the drawer as well as the payee, and the drawee.

Bills of Exchange Classification & Features

Bills of Exchange are usually classified accordingly to the class of drawee or the length of time before payment is due.

When the payment is drawn on a bank, the draft is a bank draft but when the payment is drawn on a person or an institution other than a bank, the draft is a trade draft.

Drafts are either payable on presentation i.e. sight draft or a payable at some determinable future date i.e. Time drafts. A cheque is a sight bank draft.

Note also that a draft is only an order to pay; it is not an obligation of the drawer to pay. Hence individuals receiving payment through a draft only have the credit worthiness of the drawer as assurance that payment will be made.

For instance when you write a cheque on your deposit account, your bank is not obligated to make payment unless there are sufficient funds in the account.

In the case of a time draft, the draft becomes an acceptance if the drawer agree to make payment ( by writing the word “Accepted” on the draft and signing it with a date of the acceptance).

Acceptance is widely used in trade and finance at both domestic and international levels.

  • It can be used to clear debts
  • It is used to force payment for supplies before taking titles to the goods.
  • It is used also to transfer deposit payments from one person to another.

Bills of Exchange Acceptance

These are extremely useful in commerce and as noticed above, they can be used by sellers why wish to receive payment for goods sold before the buyer pays for them.

Some one selling goods can write a trade draft on the buyer, ordering the buyer to make payment at a fixed or determinable time.

Here the seller of the goods is the drawer of the draft; the buyer of the goods is the drawee of the draft.

Drawers of drafts can also make themselves, their banks or anyone to whom they owe money the payee.

The principle works thus: when the carrier picks up goods from a seller, he or she gives the seller a receipt for the goods known as a bill of lading.

The bill of lading is sent with the draft to a bank in the town where the buyer operates.

The collecting bank will then surrender the bill of lading (which is necessary to take delivery from the carrier) to the buyer, if the buyer accepts payment of the draft

i.e. if the buyer agrees to pay the draft when it is due by writing ‘Accepted’ on the draft and endorsing it; at this point the draft becomes an acceptance, and the payee can sell it on the market for funds.

It is often sold at a discount to provide earnings to the purchase of the acceptance.  This process obtains where the transaction is international or intra-national (between regions of a particular country).

Things to Note about Bills of Exchange

Note that the efficacy of this method of financing can be reduced if the credit of the buyer is not strong. The acceptance is in effect of the buyers promise to pay, but for it to be salable in the market, there must be reason to expect that the promise will be honored.

This problem is however solved by using a time Bank draft instead of a time trade draft, so that the bank credit is used in such classes as revocable and irrevocable letters of credit demanded by foreign counter parts or firms of local trading organizations or institutions.

The buyer can arranged for a bank credit by obtaining a letter of credit from the bank.

The bank that agrees to be the drawee of the draft will send a letter of credit to the seller and charge the buyer an acceptance fee. The bank will only do this if it has received assurance that the buyer will furnish the funds before the draft becomes due.

It should be noted that the bank at no time lends money in this transaction to either the buyer of the seller, (There may be exceptions to this rule among countries).  Once a seller receives the letter of credit from the bank, the bank can be made the drawee of the draft.

When the Bank agrees to make payment, the draft becomes a banker acceptance.

A banker’s acceptance is marketed much easier than a trade draft. If a banker’s acceptance has a short maturity time, and was used to facilitate the trading of goods (i.e. it is a real bill), it can also play a role in the operation of commercial banking.

Such an acceptance or bill can be discounted with the central banks to acquire funds.

Generally, credit instruments include: Promissory Notes, Bill of Exchange, Bank Notes, Credit Cards, Cheques, Drafts, Etc.