What is Bill of Exchange? – Types, Benefits and Parties Involved
When an individual or an entity is owed money, the party might seek a legally recognised option to secure the payment. Various instruments are available in the market that can guarantee payment. A Bill of Exchange is one such instrument that allows creditors to secure their payments from their debtors.
This article delves deep into the Bill of Exchange meaning, how it works, the parties involved, its types, benefits, an example and more. Keep reading to get the details!
What is a Bill of Exchange?
As specified under the Negotiable Instruments Act of 1881, the Bill of Exchange is an instrument, in writing, that contains an unconditional order to pay a specified amount of money to the maker of the bill, to its order or to the bearer of the Bill. The Bill is payable either at a specified date or on demand as mutually agreed upon by the parties involved.
How Does the Bill of Exchange Work?
If an individual or an entity is owed money for goods sold or services delivered, the individual or entity might draw a Bill of Exchange to secure the payment. The individual or entity would be called the maker or drawer of the Bill and the person or business that owes money would be called the drawee.
The drawer would draw the Bill stating the –
- Name of the drawee
- The unconditional order of payment
- The payment date (if the Bill is payable on a specific date). If not, the date would not be mentioned. The Bill would become payable on demand
- The amount of payment
The drawer would sign the Bill and send it to the drawee.
Once the drawee signs the Bill, it is deemed as an acceptance, and the Bill becomes legally enforceable.
After that, the drawer can demand payment from the drawee either on demand or on the specified date by presenting the Bill. The drawee would, then, have to honour the Bill when presented.
If the drawer needs funds before the Bill is to be cleared, he can transfer the Bill, at a discount, to a financial institution offering the funds against the Bill. The drawer would get immediate funding while the financial institution can encash the Bill later on at the full amount and make a gain.
Example on Bill of Exchange
Here’s an example to help you understand the Bill of Exchange.
Say B owes Rs.10,000 to A.
Thus, A would draw a Bill of Exchange on B for the payment of Rs.10,000. Here A is called the drawer and B is called the drawee.
A can draw the Bill stating the payment date after 30 days. In this case, B would have to clear the Bill after 30 days when A presents it to him.
If, on the other hand, A owes money to C, A can endorse the Bill in favour of C. In this case, B would make the payment to C.
Suppose a lender offers Rs.9500 against the Bill of Rs. 10,000. A can get Rs.9500 and meet his financial needs. If A requires money within 10 days, he can discount the bill. On the other hand, the lender would get the Bill cleared after 30 days and receive Rs.10,000 from B. This would give the lender a profit of Rs.500.
Types of Bill of Exchange
The types of the Bill of Exchange are as follows:
| Types of Bills of Exchange | Meaning |
| Documentary Bill | This Bill comes with documents that authenticate that the transaction took place for which money is owed |
| Demand Bill | Bills that do not have a specified payment date and are payable on demand are called Demand Bills |
| Inland Bill | Bills drawn and honoured in one country are called Inland Bills |
| Foreign Bill | Bills that can be paid outside the country are called foreign Bills. These Bills are usually used for international trade |
| Usance Bill | Bills containing a specific time and date of payment are called Usance Bills |
| Supply Bill | The Bill that a supplier or contractor withdraws from the Government is called a Supply Bill |
| Trade Bill | Bills used in the trade business are called Trade Bills |
| Accommodation Bill | A Bill that is drawn and accepted without any condition is called an Accommodation Bill |
| Clean Bill | Clean Bills are not supported by documentary evidence. As such, they carry a higher rate of interest compared to other Bills. |
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Parties to a Bill of Exchange
Primarily, there are three parties in a Bill of Exchange. They are as follows –
- Drawer – the person or business who draws the Bill and to whom the money is owed
- Drawee – the person or business on which the Bill is drawn or who is owing money to another
- Payee – the person who would receive the payment for the Bill. Usually, the drawer and the payee are the same persons or entities if the Bill is retained till the specified date. However, the drawer might transfer the Bill to another party in which case, the other party would become the payee.
Important Features of a Bill of Exchange
Some of the important features of a Bill of Exchange are as follows –
- The Bill is a legal document
- It is always in writing
- The parties to the Bill are named therein
- The amount of payment is clearly stated in the Bill
Advantages of a Bill of Exchange
Drawing up a Bill of Exchangehas its own set of advantages. These advantages are as follows –
1. Secures Payment
The Bill of Exchangeensures that the creditor would pay the debtor. It serves as a safety net for businesses or individuals to whom money is owed. Moreover, when a specific date is mentioned, debtors can expect payment by that date and manage their cash flow requirements.
2. Can be Discounted for Instant Funding
The Bill of Exchangeoffers a discounting facility wherein debtors can encash the Bill with a third party, at a discount. They get immediate funds without waiting for the bill’s specified date. On the other hand, the third party offers a reduced amount and can get the Bill cleared at the original amount, thereby making a gain in the process.
3. Can be Endorsed
You can endorse the Bill in that individual’s name if you owe another individual. Such endorsements allow businesses to lower their existing debts.
4. Easy to Issue
The Bill of Exchange can be easily drawn and remitted to the creditor for acceptance. There is a simple Bill of Exchange format that drawers can use to draw the bill.
5. Holds Legal Identity
The Bill is a legal document that mandates the drawee to pay the specified amount on demand or at a specified date. In the case of a default, the drawer can take legal action against the drawee.
Disadvantages of a Bill of Exchange
Though beneficial, a Bill of Exchange also has its own set of drawbacks such as:
- Though discounting allows quick funds, the discount paid for the Bill is an added expense for the drawer
- It can be a short-term mode of securing payments from creditors
- The drawee becomes legally bound to clear the payment on demand or on the specified date
Final Word
As a business or an individual, if a creditor owes you money, you can secure your debt with the help of a Bill of Exchange.Draw the Bill stating the debt and the debtor’s details and get the debtor to accept it. Once accepted, the Bill becomes a legal document and secures your debt payment. If you need funds before the Bill is due, you can discount the Bill with a financial institution and get access to funds for your business.
FAQs
Ans: No, usually, no interest is charged on the Bills of Exchange. However, in certain cases, the Bill might carry an interest.
Ans: The Bill of Exchange is quite different from a Promissory Note. The differences are as follows:
The Bill is drawn by the debtor while the Note is drawn by the creditor
The Bill states an order for the drawee to pay. The Note contains an undertaking by the drawer to pay
The drawee should accept the Bill of Exchange. This acceptance is not required for the Promissory Note
The drawer and payee of the Bill can be the same. The drawer and payee of the Note can never be the same
The Bill can have multiple copies while the Note cannot.
Ans: If the drawee is unable to pay the amount stated on the Bill on demand or on the specified date, it would be called a dishonour of the Bill. On such a dishonour, a notice is served to all parties to Bill
Ans: In case the due date is a National holiday, the Bill would become payable one day before the due date. For instance, say the due date on the Bill is 15th August. In this case, the drawee would have to pay the Bill on 14th August.
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Disclaimer: This article has been prepared on the basis of internal data, publicly available information and other sources believed to be reliable. The information contained in this article is for general purposes only and not a complete disclosure of every material fact. It should not be construed as investment advice to any party. The article does not warrant the completeness or accuracy of the information, and disclaims all liabilities, losses and damages arising out of the use of this information. Readers shall be fully liable/responsible for any decision taken on the basis of this article.
