What is a Bill of Exchange?
A bill of exchange refers to a financial instrument explicitly used for international trade to bind one party to pay a specified amount of money to the holder of the document or another designated person. The bill of exchange is paid after a specified term or on-demand. Other financial instruments similar to a bill of exchange are promissory notes and checks that can be drawn by banks or individuals and are also transferable through endorsements.
How Does a Bill of Exchange Work?
Bills of exchange are usually used when there is a business transaction that involves credit purchases. In this case, the creditor (seller) will issue the debtor (buyer), or a financial entity acting as intermediary, a bill of exchange based upon what is owed for the goods. Note that for a bill of exchange to be valid, the debtor (or drawee) has to accept it first. After acceptance, the bill of exchange creates the obligation for the buyer or drawee to pay the creditor.
Who are the Parties Involved in a Bill of Exchange?
Though there are several parties involved in a bill of exchange, the most common and main entities are as follows:
- Drawer: This is the party that makes the bill ordering the payment of a specified amount of money. This party is the drawer of the instrument and obliges the drawee to make payments to the payee.
- Drawee: This is an entity that receives the bill of exchange directing him to make payment of the specified amount of money.
- Payee: This party is the one that receives a payment made by the drawee as specified in the bill of exchange.
What are the Types of Bill of Exchange?
There are two types of bills of exchange. A bill of exchange issued by a banks is known as bank drafts. If an individual issues the document, it is known as a trade draft. The two types of bill exchange are as follows:
- Sight bill: This is a type of bill of exchange where payment is immediate payment or on-demand.
- Term bill: With this type of bill of exchange payment is for a later date (payment is made at a specified time in the future).
Bill of Exchange Features During a business transaction where be buyer purchases the goods on credit, the seller prepares the bill typically and sends it to the purchaser of goods (or a drawee bank) for acceptance. The bill usually contains specific details such as:
- Name and the address of the buyer and seller
- The billing amount
- Bill maturity date
- Signatures and stamps of both parties (seller and buyer)
A bill of exchange is transferable. The payee can legally transfer the bill to another entity through what we call an endorsement, generally done at the back of the document.
