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What is a bill of exchange in export? Understand its types, uses, format, and benefits

A bill of exchange is a negotiable instrument made by the exporter addressed to the importer. Learn more about its format, types, and uses in international trade.

In trade and commerce, goods are often bought or sold through credit transactions. In such situations, to avoid any possibility of delay or default, an instrument of credit is used to assure the seller or exporter that the payment will be made according to the agreed-upon terms. One such instrument of credit that is widely used in international trade is called a bill of exchange. In this blog post, we will discuss the format of a bill of exchange, its types, working, and function in exports.

What is a bill of exchange?

A bill of exchange is an important document in export that contains essential details of an export transaction, such as the invoice amount, payment terms, bank details, etc. It is a written order that guarantees that one party will pay another party a predetermined amount according to specified payment terms.¹

What are the different types of bills of exchange?

Bills of exchange can be of various types depending on certain factors:

1. Type of issuer:

• Bank draft: A bill of exchange issued by a bank is called a bank draft. In this case, the issuing bank guarantees payment on the transaction.

• Trade draft: Bills of exchange that are issued by individuals are called trade drafts.

2. Time period:

• Sight draft: If the payment is to be made immediately or on demand, the bill of exchange is called a sight draft. This allows an exporter to hold title to the exported goods until the importer takes delivery and immediately pays for them.

• Time draft: A time draft is a type of bill of exchange where the payment is set for a specific date in the future. This gives the importer some time to pay the exporter for the goods after receiving them.²

Parties to a bill of exchange

A bill of exchange usually involves three essential parties who play different roles in the transaction:

Drawer

The drawer is the person who creates and signs the bill, representing the creditor or the party entitled to receive payment.

Drawee

The drawee is the individual or entity upon whom the bill is drawn, typically the debtor responsible for making the payment.

Payee

The payee is the designated recipient of the payment mentioned in the bill. It can be the drawer themselves or a third party entitled to receive the funds.

How does a bill of exchange work?

A bill of exchange procedure can be carried out in two ways. The first assumes that the payee and the drawer are the same entity; they are responsible for both creating the bill and receiving the payment. There are only two parties involved in this setup.

For example, let us assume that a textile exporter is supplying fabric to a garment manufacturer. They stipulate the payment amount and deadline for payment. After exporting the goods, the exporter will present the bill of exchange to the manufacturer, who must pay the amount according to the agreed terms. Once the payment is received, the bill of exchange is considered settled.

In the other scenario, the textile exporter can request payment from their bank. In this instance, the bank will draft and issue the bill of exchange to the manufacturer who must oblige and pay the exporter. In this situation, the bank acts as a third party that serves as an intermediary.⁴

Contents of a bill of exchange

Some of the details that are covered in a bill of exchange are:

• Name of the drawer, i.e., the person who writes the bill
• Name of the recipient
• Details of the payee
• Payment date
• Identification number
• Signature of the drawer⁵

Advantages of a bill of exchange

The advantages of a bill of exchange in international trade are as follows:

Legal evidence

A bill of exchange in export serves as a legally binding document, providing strong evidence of the debt owed. In case of any dispute or non-payment, the drawer can utilize the bill as proof to initiate legal action and recover the amount due.

Fixed amount and date

The clear specification of the amount and due date on a bill of exchange ensures transparency and certainty for both parties involved. This eliminates any ambiguity or confusion regarding the payment obligations and facilitates proper financial planning.

Discounting facility

One significant advantage of a bill of exchange is the discounting option. If the drawer or holder requires immediate funds before the maturity date, they can sell the bill to a bank or financial institution at a discounted rate. This allows for early cash realization and improves cash flow.

Negotiable

A bill of exchange, particularly when payable to the bearer, offers negotiability. This means that it can be transferred from one person to another, settling debts or facilitating trade transactions. The negotiability of bills of exchange enhances their liquidity and flexibility.

Full credit period for drawee

The drawee, who is obligated to make the payment on the due date, benefits from the full credit period granted by the bill of exchange. They are not compelled to make the payment earlier than the specified date, allowing them to manage their cash flow more effectively and utilise the funds until the bill matures.⁶

Disadvantages of a bill of exchange

Limited suitability for long-term services

Bills of exchange are majorly used for short-term transactions and may not be an ideal option for long-term financial arrangements.

Drawee’s responsibility for timely payment

The drawee is obligated to pay the amount specified in the bill by the due date, which can put pressure on their financial resources and cash flow management.

Unsuitability for banking services

Bills of exchange are generally considered unsuitable for various banking services due to their inherent complexities and limited flexibility compared to other financial instruments.

Additional burden with bill discounting

If a bill of exchange is discounted, the drawee may incur additional costs or fees, adding to their financial burden.⁷

How can an exporter create a Bill of Exchange?

A Bill of Exchange usually includes three parties:

Drawee: The party that pays the sum
Payee: The party who receives the sum
Drawer: The one that obliges the drawee to pay the payee

Any exporter who is entitled to receive money from an importer or a buyer can draw a bill of exchange. Considering the above example where an export transaction took place between a textile exporter and a garment manufacturer, the exporter will be the drawer of the bill of exchange, and the manufacturer will be the drawee.

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Frequently Asked Questions

Is a cheque a bill of exchange?

A cheque is similar to a bill of exchange in its mode of functioning. However, unlike a cheque, a bill of exchange is a written document outlining a debtor’s indebtedness to the creditor. Moreover, a cheque always involves a bank while a bill of exchange may or may not involve a bank.⁸

What is the difference between a Bill of exchange and a bill of lading?

A Bill of exchange is for financing a transaction between two parties, whereas a Bill of Lading is a shipping document that a freight forwarder or a shipping carrier issues to a cargo owner.⁹

What is the difference between a bill of exchange and a promissory note?

A bill of exchange is an order from the creditor to the debtor to pay a specified amount. On the other hand, a promissory note is issued by the debtor who promises to pay a particular amount by a set date.¹⁰

What does ‘discounting the bill of exchange’ mean?

Discounting a bill of exchange is when the bank pays the payee before the bill’s maturity date. The bank deducts some interest (known as a discount) and makes the payment to the payee. This process allows the holder to obtain immediate funds by encashing the bill with the bank. The bank recovers the amount from the drawee on the bill's due date.¹¹

When is interest included in a Bill of exchange?

In a bank bill of exchange, the bank acts as the drawer and guarantees the payment to the payee. It is a secure form of payment and is commonly used by businesses for large transactions.¹²

What is the transferability of a bill of exchange?

The transferability of a bill of exchange refers to the ability to transfer the rights and obligations stated in the bill from one party to another. When a bill is transferable, the payee has the option to transfer the bill to a third party payee.¹⁴

What is the first and second bill of exchange?

The bill of exchange can be drawn in singular or in duplicate. In the case of a singular bill of exchange, the word ‘sole’ is to be inserted. In case of a bill of exchange in duplicate, the word ‘first (second being unpaid)’ is to be inserted on the first copy and ‘second (first being unpaid)’ on the second copy.¹⁵

What do you mean by bill of exchange at sight?

This type of bill of exchange is payable immediately upon being presented to the drawee.¹⁶

Published on July 21, 2022.

Sources:
1. https://www.investopedia.com/terms/b/billofexchange.asp#toc-who-are-the-parties-to-a-bill-of-exchange
2. https://www.investopedia.com/terms/b/billofexchange.asp#toc-who-are-the-parties-to-a-bill-of-exchange
3. https://www.financestrategists.com/accounting/bill-of-exchange/
4. https://www.volopay.com/in/blog/bill-of-exchange/
5. https://khatabook.com/blog/bill-of-exchange
6. https://www.financestrategists.com/accounting/bill-of-exchange/#advantages-of-bill-of-exchange
7. https://blog.ipleaders.in/all-you-need-to-know-about-a-bill-of-exchange/#Parties_to_a_bill_of_exchange
8. https://www.investopedia.com/terms/b/billofexchange
9. https://byjus.com/commerce/difference-between-bill-of-exchange-and-bill-of-lading/#
10. https://www.investopedia.com/terms/b/whats-the-difference-between-bill-of-exchange-and-promissory-note
11. https://byjus.com/question-answer/discuss-the-meaning-of-discounting-bills-of-exchange/
12. https://www.investopedia.com/terms/b/billofexchange.asp#
13. https://www.investopedia.com/terms/b/billofexchange.asp#toc-example-of-bill-of-exchange
14. https://www.investopedia.com/terms/b/billofexchange.asp
15. https://www.abnamro.nl/en/media/Leaflet_Bill_of_Exchange_tcm18-202986.pdf
16. https://www.investopedia.com/terms/b/billofexchange.asp

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