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What is a bill of exchange? Understand its meaning, 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.
Bill of exchange
Businesses frequently encounter situations where immediate cash transactions are not feasible. This necessitates the use of credit instruments that facilitate smooth transactions and ensure financial security. One such critical financial tool is the bill of exchange. This document serves as a conditional order, offering a structured approach to deferred payments. This blog post explores the meaning of bills of exchange, their types, uses, formats, and benefits.
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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 types of bills of exchange?

Understanding the various types of bills of exchange can help sellers select the appropriate instrument for specific business needs. Some common types include:

1. Inland bill

An inland bill is drawn and payable within the same country. This means that both the drawer and the drawee, and the place of payment, are located within the same nation. It simplifies domestic transactions and is governed by national commercial laws.

2. Foreign bill

A foreign bill involves parties from different countries and is used for cross-border payments in international trade. These bills are subject to international trade laws and are often used in import and export transactions, where different currencies and legal systems are involved.

3. Trade bill

This bill is used in genuine credit-based sales of goods or services, representing a commercial debt. It is a direct reflection of a sale of goods or services, making it a tangible representation of a commercial obligation. It is a common tool for businesses engaged in regular trade activities.

4. Accommodation bill

This bill is drawn without a genuine trade transaction, primarily to provide financial accommodation to one or both parties. It serves as a form of short-term financing. Unlike trade bills, accommodation bills are not tied to a specific commercial transaction and are often used to provide temporary financial assistance.

5. Demand bill

This bill is payable on demand or sight, meaning the drawee must pay the amount immediately upon presentation. This type of bill provides immediate access to funds, making it suitable for transactions requiring prompt payment.

6. Usance bill

This bill is payable after a specified period of time, giving the drawee a period of credit. The usance period allows the drawee to manage their finances and plan for payment. It is commonly used in trade transactions where credit terms are agreed upon.2

Importance of bill of exchange

Bill of exchange offers numerous benefits to businesses, including:

Legal assurance:

Provides a legally binding commitment for payment, reducing the risk of default.

Financial planning:

Specifies payment dates, aiding in cash flow management for both parties.

Negotiability:

Can be transferred or discounted, offering liquidity to holders.

Credit extension:

Facilitates the extension of credit in commercial transactions, promoting smoother trade operations.

Features of bill of exchange

A bill of exchange is a crucial financial instrument in trade and commerce. Some of its key features are:
● Written and signed instrument:
A bill of exchange must be in writing and signed by the drawer. It serves as a formal, legally binding document.
● Unconditional order to pay:
The bill must include a clear, unconditional order to pay a specified amount. Any condition attached to payment invalidates the bill.
● Specific amount mentioned:
The amount to be paid must be clearly stated and should not be subject to change.
● Defined maturity date:
A bill of exchange is payable on a fixed date, after a specific period, or on demand. The maturity date must be clearly mentioned.
● Payee name and payment details:
The bill must include the name of the payee. It also mentions where and how the payment should be made.
● Acceptance requirement:
Typically, the bill requires acceptance from the drawee before it becomes valid. Once accepted, the drawee has to fulfil the payment obligation.
● Legally enforceable:
It is legally enforceable under commercial laws, making it a reliable financial instrument.
● Transferability:
A bill of exchange can be transferred through endorsement, allowing it to be used as a negotiable instrument in trade finance.4

Functions of bill of exchange

A bill of exchange plays a crucial role in trade and financial transactions. Some of its key functions are:

Facilitates international trade transactions

A bill of exchange provides a secure written agreement for payments, ensuring trust between buyers and sellers.

Serves as a credit instrument

It allows buyers to obtain goods and services on credit while assuring the seller of future payment. Businesses often use it to manage cash flow and working capital efficiently.

Ensures legal protection

Since a bill of exchange is a legally enforceable document, it provides legal recourse in case of non-payment. The bill records the amount due, the parties involved, and the payment terms. It minimizes disputes related to payments by establishing clear obligations.

Provides a negotiable financial instrument

It can be transferred from one party to another through endorsement, making it a flexible financial tool in commerce. Banks and financial institutions often discount bills of exchange to provide immediate cash to businesses.5

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.

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

Example of bill of exchange

Let us consider an example to understand how a bill of exchange works. Consider Company A, a textile exporter in India. It sells fabrics worth ₹25,00,000 to Company B, a Dubai-based company. To guarantee payment, Company A issues a bill of exchange, instructing Company B (drawee) to pay the specified amount within 90 days. Company B must accept the bill for it to become legally binding.

Company A then discounts the accepted bill with State Bank of India (SBI), receiving early payment at a discounted rate. SBI, now the holder of the bill, will collect the full amount from Company B on or before the due date.

This arrangement benefits all parties: Company A gains immediate liquidity, SBI earns a discount margin, and Company B receives a deferred payment period. If Company B fails to honor the bill, SBI (or Company A, depending on the terms of discounting) can seek legal recourse.

Role of issuer in bill of exchange

The issuer, or drawer, initiates the bill of exchange and plays a pivotal role in the transaction. Their responsibilities include:

● Drafting the bill:

The issuer creates the bill with all necessary details, including amount, date, and parties involved.

● Ensuring acceptance:

They present the bill to the drawee for acceptance, making it a binding obligation.

● Negotiation:

They may endorse and transfer the bill to third parties if needed.

● Legal recourse:

The issuer holds the right to legal action if the drawee defaults on payment.6

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.

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 drawee
● Payment date
● Identification number
● Signature of the drawer.7

Sample format of bill of exchange

Advantages of bill of exchange

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

● Legal evidence

An inland bill is drawn and payable within the same country. This means that both the drawer and the drawee, and the place of payment, are located within the same nation. It simplifies domestic transactions and is governed by national commercial laws.

● Fixed amount and date

A foreign bill involves parties from different countries and is used for cross-border payments in international trade. These bills are subject to international trade laws and are often used in import and export transactions, where different currencies and legal systems are involved.

● Discounting facility

This bill is used in genuine credit-based sales of goods or services, representing a commercial debt. It is a direct reflection of a sale of goods or services, making it a tangible representation of a commercial obligation. It is a common tool for businesses engaged in regular trade activities.

● Negotiability

This bill is drawn without a genuine trade transaction, primarily to provide financial accommodation to one or both parties. It serves as a form of short-term financing. Unlike trade bills, accommodation bills are not tied to a specific commercial transaction and are often used to provide temporary financial assistance.

● Full credit period for drawee

This bill is payable on demand or sight, meaning the drawee must pay the amount immediately upon presentation. This type of bill provides immediate access to funds, making it suitable for transactions requiring prompt payment.8

Disadvantages of 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.9

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Frequently Asked Questions

1. 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.10
2. 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.11
3. 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.12
4. 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.13
5. When is interest included in a bill of exchange?
Interest on a bill of exchange is typically included when the bill is not paid by the specified due date, or if the bill explicitly states that interest will be charged on overdue payments.
6. 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.
7. 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.14
8. 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.
Published on July 21, 2022.
Updated on May 6, 2025.

Sources:
1. https://www.investopedia.com/terms/b/billofexchange.asp#toc-who-are-the-parties-to-a-bill-of-exchange
2. https://lawbhoomi.com/kinds-of-bill-of-exchange/
3. https://www.bajajfinserv.in/bill-of-exchange
4. https://razorpay.com/blog/business-banking/bill-of-exchange/
5. https://www.kredx.com/supply-chain-finance/invoice-discounting/bill-of-exchange
6. https://www.credlix.com/blogs/bill-of-exchange-meaning-format-and-types
7. https://khatabook.com/blog/bill-of-exchange
8. https://www.financestrategists.com/accounting/bill-of-exchange/#advantages-of-bill-of-exchange
9. https://blog.ipleaders.in/all-you-need-to-know-about-a-bill-of-exchange/#Parties_to_a_bill_of_exchange
10. https://testbook.com/key-differences/difference-between-cheque-and-bill-of-exchange
11. https://byjus.com/commerce/difference-between-bill-of-exchange-and-bill-of-lading/#
12. https://www.investopedia.com/terms/b/whats-the-difference-between-bill-of-exchange-and-promissory-note
13. https://byjus.com/question-answer/discuss-the-meaning-of-discounting-bills-of-exchange/
14. https://www.abnamro.nl/en/media/Leaflet_Bill_of_Exchange_tcm18-202986.pdf

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