What Is a Bill of Exchange?
Let me tell you directly: a bill of exchange is like an invoice you present when exchanging goods or services, but it's more formal. It's a written order, mainly used in international trade, that binds one party to pay a fixed sum of money to another party either on demand or at a predetermined date. These are similar to promissory notes; you or a bank can draw them up, and they're generally transferable through endorsements.
Key Takeaways
Understand this: a bill of exchange binds one party to pay a fixed sum to another on demand or at some point in the future. It's used in international trade to help importers and exporters complete their transactions. While it's not a contract itself, the parties involved can use it to specify transaction terms, such as the interest rate.
Using Bills of Exchange
You use a bill of exchange in international trade to pay for goods or services. Even though it's not a contract, you and the other parties can rely on it and its format to fulfill a contract. It can specify that payment is due on demand or at a specified future date. The period between billing and payment is called the usance, and it's often extended with credit terms, such as 90 days.
A transaction can involve up to three parties. The drawee is the one who pays the sum specified. The payee receives that sum. The drawer is the party that obliges the drawee to pay the payee. The drawer and payee are the same unless the drawer transfers the bill to a third-party payee.
Bills of exchange generally don't pay interest, making them essentially post-dated checks. They may accrue interest if not paid within an agreed timeline, and you must specify the rate on the instrument. Remember, a bill of exchange must be accepted by the drawee to be valid.
Types of Bills of Exchange
- Bank Draft: A bill of exchange issued by a bank, where the issuing bank guarantees payment on the transaction.
- Trade Draft: Bills of exchange issued by individuals.
- Sight Draft: Funds are paid immediately or on demand; in international trade, it allows an exporter to hold title to goods until the importer pays upon delivery.
- Time Draft: Funds are paid at a set date in the future, giving the importer a short time to pay after receiving the goods.
Example
Suppose Company ABC purchases auto parts from Car Supply XYZ for $25,000. Car Supply XYZ draws a bill of exchange, acting as both drawer and payee. The bill stipulates that Company ABC will pay $25,000 in 90 days. Company ABC becomes the drawee, accepts it, and the goods are shipped.
In 90 days, Car Supply XYZ presents the bill to Company ABC for payment. This bill was an acknowledgment created by the creditor, Car Supply XYZ, to show the indebtedness of the debtor, Company ABC.
What Are Some Differences Between a Bill of Exchange and a Check?
Checks are payable on demand, while a bill of exchange can specify payment on demand or at a future date. Unlike a check, a bill of exchange is a written document outlining a debtor's indebtedness to a creditor.
Why Are Bills of Exchange Useful in International Trade?
Bills of exchange are useful in international trade because they help buyers and sellers manage risks from exchange rate fluctuations and differences in legal jurisdictions.
What's the Difference Between a Bill of Exchange and a Promissory Note?
The key difference is that a bill of exchange is transferable and can bind one party to pay a third party not involved in its creation. Banknotes are common promissory notes. A creditor issues a bill of exchange ordering a debtor to pay a particular amount within a given period, while a debtor issues a promissory note promising to repay money.
The Bottom Line
Bills of exchange facilitate international trade by stipulating payment from one party to another at a specified date. They aren't contracts but can be used to fulfill contract terms.
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