What is a bill of exchange

Bill of Exchange Definition & Examples

Last edited Jul 2021 — 2 min read

You have big dreams and even bigger ambitions. You may run a successful small business but certainly don’t want it to stay small. You want to expose your brand and your products to new customers in new markets. If you’re tired of being a big fish in a small pond, you may have your sights set on growth to overseas markets.

But international trade brings with it a unique set of risks and complexities, especially in the post- Brexit landscape. Bills of exchange are used by businesses and banks all over the world to provide assurance and protection. If you want to forge great relationships with overseas clientele, you’ll need to familiarise yourself with bills of exchange.

Let’s take a look at what they are and how they work.

What is a bill of exchange?

A bill of exchange is often used to protect the transaction. It is a binding agreement between buyer and seller where the buyer agrees to pay a fixed sum of cash at a predetermined date or upon demand from the seller. Banks usually act as third parties in bills of exchange to ensure payment and receipt of funds.

What information needs to be included in a bill of exchange?

In order to be legally binding, a bill of exchange will need to contain the following information:

Title – The document needs to have the term «bill of exchange» clearly noted on the face.

Amount – The sum to be paid needs to be clearly stated both numerically and in text.

As of – This refers to the time period when the amount is to be paid. This may be upon delivery, upon shipment or upon a predetermined date.

Payee – The name (and possibly the address) of the party to be paid.

Identification number – Each bill of exchange must have its own unique identification number.

Signature – The bill must be signed by someone authorised to commit the buyer / drawee to pay the designated sum.

Bills of exchange are not usually subject to interest. However, if payments are subject to interest if not settled by a certain date, the rates and terms need to be clearly stated on the bill.

Is a bill of exchange the same as a promissory note?

Bill of exchange example

Let’s say you own a vehicle repair shop that specialises in repairs and parts sales for American cars. This will, inevitably, require you to order parts from overseas. Let’s say you purchase £10,000 in parts from a vendor in the States. They may then draw up a bill of exchange stipulating that payment of £10,000 will need to be made within 30 days.

You will receive and accept the terms of the bill of exchange. Because the agreement now binds both parties, the goods can be safely dispatched. The bill of exchange acknowledges the debt between the creditor (the vendor) and the debtor (you).

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Bill of Exchange

What Is a Bill of Exchange?

A bill of exchange is a written order used primarily in international trade that binds one party to pay a fixed sum of money to another party on demand or at a predetermined date. Bills of exchange are similar to checks and promissory notes—they can be drawn by individuals or banks and are generally transferable by endorsements.

Key Takeaways

Bill of Exchange

Understanding Bills of Exchange

A bill of exchange transaction can involve up to three parties. The drawee is the party that pays the sum specified by the bill of exchange. The payee is the one who receives that sum. The drawer is the party that obliges the drawee to pay the payee. The drawer and the payee are the same entity unless the drawer transfers the bill of exchange to a third-party payee.

Unlike a check, however, a bill of exchange is a written document outlining a debtor’s indebtedness to a creditor. It’s frequently used in international trade to pay for goods or services. While a bill of exchange is not a contract itself, the involved parties can use it to fulfill the terms of a contract. It can specify that payment is due on demand or at a specified future date. It’s often extended with credit terms, such as 90 days. As well, a bill of exchange must be accepted by the drawee to be valid.

Bills of exchange generally do not pay interest, making them in essence post-dated checks. They may accrue interest if not paid by a certain date, however, in which case the rate must be specified on the instrument. They can, conversely, be transferred at a discount before the date specified for payment. A bill of exchange must clearly detail the amount of money, the date, and the parties involved including the drawer and drawee.

If a bill of exchange is issued by a bank, it can be referred to as a bank draft. The issuing bank guarantees payment on the transaction. If bills of exchange are issued by individuals, they can be referred to as trade drafts. If the funds are to be paid immediately or on-demand, the bill of exchange is known as a sight draft. In international trade, a sight draft allows an exporter to hold title to the exported goods until the importer takes delivery and immediately pays for them. However, if the funds are to be paid at a set date in the future, it is known as a time draft. A time draft gives the importer a short amount of time to pay the exporter for the goods after receiving them.

Bills of exchange are useful in international trade because they help buyers and sellers deal with the risks associated with exchange rate fluctuations and differences in legal jurisdictions.

The difference between a promissory note and a bill of exchange is that the latter is transferable and can bind one party to pay a third party that was not involved in its creation. Banknotes are common forms of promissory notes. A bill of exchange is issued by the creditor and orders a debtor to pay a particular amount within a given period of time. The promissory note, on the other hand, is issued by the debtor and is a promise to pay a particular amount of money in a given period.

Example of Bill of Exchange

What Are Some Differences Between a Bill of Exchange and a Check?

A check always involves a bank while a bill of exchange can involve anyone, including a bank. Checks are payable on demand while a bill of exchange can specify that payment is due on demand or at a specified future date. Bills of exchange generally do not pay interest, making them in essence post-dated checks. They may accrue interest if not paid by a certain date, but that rate must be specified on the instrument. Unlike a check, a bill of exchange is a written document outlining a debtor’s indebtedness to a creditor.

Who Are the Parties to a Bill of Exchange?

A bill of exchange transaction can involve up to three parties. The drawee is the party that pays the sum specified by the bill of exchange. The payee is the one who receives that sum. The drawer is the party that obliges the drawee to pay the payee. The drawer and the payee are the same entity unless the drawer transfers the bill of exchange to a third-party payee.

What Are the Different Types of Bills of Exchange?

A bill of exchange issued by a bank is referred to as a bank draft. The issuing bank guarantees payment on the transaction. A bill of exchange issued by individuals is referred to as a trade draft. If the funds are to be paid immediately or on-demand, the bill of exchange is known as a sight draft. In international trade, a sight draft allows an exporter to hold title to the exported goods until the importer takes delivery and immediately pays for them. However, if the funds are to be paid at a set date in the future, it is known as a time draft which gives the importer a short amount of time to pay the exporter for the goods after receiving them.

What’s the Difference Between Bill of Exchange and Promissory Note?

The difference between a promissory note and a bill of exchange is that the latter is transferable and can bind one party to pay a third party that was not involved in its creation. Banknotes are common forms of promissory notes. A bill of exchange is issued by the creditor and orders a debtor to pay a particular amount within a given period of time. The promissory note, on the other hand, is issued by the debtor and is a promise to pay a particular amount of money in a given period.

Bills of exchange: what are they and how do they work?

Last edited Oct 2020 — 2 min read

Payments are critical to any business. However, as anyone who has chased an invoice is sure to know, ensuring payment isn’t always easy. A bill of exchange is designed to keep everyone accountable when it comes to making payments on time. Find out everything you need to know about bills of exchange in Australia, including the Bill of Exchange Act 1909, with our helpful guide.

What is a bill of exchange?

A bill of exchange is essentially a formal, written IOU that states when a certain amount of money needs to be paid. Sometimes known as an international bill of exchange, they are similar to a contract, binding one party to an agreed-upon payment amount.

What are the key features of a bill of exchange?

A bill of exchange must feature the following:

It must be a written document

It must name all relevant parties

It must be addressed from one party to another

It must bear the signature of the party giving it

It must outline the time when the money is due

It must outline the amount of money that must be paid

Another notable feature of a bill of exchange is that it features three parties, which are as follows:

The drawer: the party who writes the bill and orders the money be paid

The drawee: the party who is required to pay

The payee: the party who is due to be paid

That means the drawer who demands the money in the first place is not necessarily the one due to be paid. An international bill of exchange allows one party to demand payment to a third party.

Is a bill of exchange a legal document?

What’s the difference between a cheque and a bill of exchange?

A bill of exchange is similar to a cheque in the sense that similar details must be included, while both documents function as requests for payment from one party to another. However, a cheque is slightly more straightforward in that it is merely a request from a bank’s customer to have the bank pay someone from a specific account. A bill of exchange requests that the recipient makes payment, regardless of where the funds originated.

A cheque clearly states where the money will come from and is far more direct: one person writes the cheque, one person banks it, and the bank fulfils it. In the case of a bill of exchange, the bill writer may have no further involvement in actually paying the amount. However, they should assist the payee where the drawee is late or reluctant, so they retain some accountability.

How to utilise an international bill of exchange

A bill of exchange can be used in situations wherein Company A requests payment from Company B, and Company B assigns the payment to Company C to streamline the process. When it comes to international bills of exchange, it’s the same process, but on a global scale.

For example, imagine that Company A sells books purchased from Company B, which in turn, places orders with Company C. Company B places an order with Company C and produces a bill of exchange that requires Company A to pay Company C upon receipt of the order.

Company B’s debt to Company C is paid with money owed by Company A. Although this may seem somewhat inconvenient, the main benefit of bills of exchange is the fact that they do not have to be paid immediately. In more recent times, bills of exchange have become less commonly used, with other delayed payment methods, like credit cards, becoming far more popular.

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Bill of Exchange

Bill of Exchange: Definition

A bill of exchange is defined as follows:

An unconditional order in writing, addressed by one person to another, signed by the person giving it, requiring the person to whom it is addressed to pay on demand or at a fixed or determinable future time a certain sum in money to (or to the order of) a specified person or to bearer.

Bill of Exchange: Key Points

To better understand the above definition of bill of exchange, the following points should be kept in mind:

Unconditional

Bearing no condition means that there is no condition attached to the bill.

Order

A bill of exchange is an order to pay certain money. It is not a request.

Giving Person

The person who makes (i.e., writes) the bill is the person who orders to pay the amount of the bill. This individual is called the drawer.

Addressed Person

The person upon whom the bill is drawn or the person to whom the order is given is known as the drawee. This individual accepts the bill by writing the word “Accepted” across the face of the bill and signing it.

On-Demand

The bill is payable whenever the amount of the bill is demanded (only in the case of sight bill).

Fixed Time

A clear and certain time in the future (e.g., 10 December 2019).

Determinable Future Time

A future time that can easily be determinable (e.g., 90 days after the date of drawing the bill).

Certain Sum in Money

Payee

The payee is the person to whom the amount of the bill is paid.

The amount of the bill can be paid to the drawer, or to someone else, as per the order of the drawer or to the person who presents the bill on the due date.

This is why definition contains the phrase” to or to the order of a specified person or to bearer.”

Explanation

In this modern age of competition, credit selling is an evil that every businessperson has to engage in. This is because credit sales are one of the strongest tools to enhance net income.

The refusal to give credit means that competitors may win potential sales. However, no businessperson wants to sell goods on credit to customers who may not pay their debts.

Firstly, remember that businesspeople always seek to promote sales and, alongside this, to secure money and customers. A seller wants to realize the amount of goods sold as soon as possible, maximizing the goods sold and minimizing the chance of bad debts can be minimized.

In contrast to a seller, a buyer wants to get maximum credit period. Is there any method that satisfies both the parties? The answer is yes.

There is a payment method, known as bill of exchange, that provides the seller with evidence of amount receivables as well as the amount of goods sold. Noteworthily, this method also offers a sufficient credit period to the buyer.

The bill of exchange method of payment has several advantages compared to other methods.

Specimen/Format of Bill of Exchange

Parties to a Bill of Exchange

There are three main parties involved in a bill of exchange: drawer, drawee, and payee.

Drawer

The drawer is the maker of the bill. They draw or writes the bill and they sign the bill. Although a bill can be accepted before receiving the drawer’s signature, their signature is required to complete the document.

Drawee

The drawee is the person upon whom a bill of exchange is drawn, or the drawee is the person who accepts the bill and promises to pay the amount. When the drawee accepts the bill, he becomes the acceptor.

Payee

The payee is the person who is named in the instrument as the individual who the amount of the bill should be directed toward to be paid. As such, the payee is the person who receives the amount of the bill.

The payee may be the drawer or someone else. If the drawer keeps the bill with themselves until the due date and receives the amount of the bill, then the drawer and payee are the same person.

There are also other parties involved in a bill of exchange, including:

Holder of the Bill

The holder of a bill of exchange is the person who is entitled in their own name to the possession of the instrument and to receive the amount due thereon.

It is not only possession but also entitlement to possession that makes a person the holder of the bill. Thus, a person in possession of a stolen or lost bill cannot be a holder.

Holder in Due Course

Any person who, for consideration, becomes the possessor of a bill payable to the bearer is known as the holder in due course. Amy person who has received the bill from the previous holder is called a holder in due course.

Drawee in Case of Need

Sometimes, in bills of exchange, the name of a third person is mentioned. If the original drawee does not accept or pay the bill, then this third person will accept and pay the bill. This third person is known as the drawee in case of need.

Acceptor for Honor

If the original drawee refuses the bill and the holder of the bill gets the bill noted and protested due to non-acceptance, then any person who is not already liable to accept the bill may accept the bill with the consent of the holder. This person is known as the acceptor for honor.

Types of Bill of Exchange

A bill of exchange can be classified based on the following three bases:

By Time Period

By Objective

By Territory

Demand Bill of Exchange

A bill with no fixed payment date. It is payable at the time when it is presented by the holder. Days of grace are not allowed on a bill of this kind. A demand bill is also known as a sight bill.

Term Bill of Exchange

A bill drawn for a specific time period. This type of bill has either a fixed future date or determinable future time.

Trade Bill of Exchange

A bill drawn and accepted due to the sale and purchase of goods on credit. This type of bill is drawn by the creditor (seller) and accepted by the debtor (buyer).

Accommodation Bill of Exchange

A bill drawn and accepted without the sale and purchase of goods. The main purpose of this bill is to provide financial assistance to one or both parties. The bill does not come into existence due to any trading activity.

Inland Bill of Exchange

A bill drawn, accepted, and payable in the same country. Both the drawer and acceptor of this bill live in the same country.

Foreign Bill of Exchange

A bill drawn in one country and accepted and payable in another country. Both the drawer and drawee of this bill live in two different countries.

Acceptance of Bill of Exchange

The drawee is not liable to pay the bill until they accept the bill. Therefore, the drawee’s acceptance of the bill of exchange is necessary to complete the instrument.

The act of signing and writing the words “Accepted” across the face of the bill by the drawee is called acceptance. The advantage of acceptance is that it fixes the liability on the drawee.

Types of Acceptance

Acceptance is of the following two kinds:

General Acceptance

If the bill of exchange is accepted without any condition to the order of the drawer, the acceptance is termed as general acceptance.

Qualified Acceptance

When a bill of exchange is accepted with any qualification or condition to the order of the drawer, the acceptance is known as qualified acceptance.

Qualified acceptance is separated into the following types:

Tenor of the Bill of Exchange

The time period after which a bill of exchange is matured is called the “tenor” of the bill.

For example, if a 90-day bill is drawn and accepted, the bill will be matured after 90 days. So, the tenor of this bill is 90 days.

Days of Grace

In the business community, when the due date of a bill is calculated, it is customary that after maturity of the bill, three extra days are given to the drawee for the payment of the bill. These extra days are called days of grace.

Usance

Usance refers to the period of time for the payment of the bill which is fixed by the tradition of the market.

For example, consider a 90-day bill that will be matured after 90 days. Therefore, tenor of the bill is 90 days. However, three extra days will be given to the drawee for payment of the bill. Here, the usance of the bill is 93 days.

Maturity of Bill of Exchange

A term bill matures when its tenor expires. Therefore, maturity of the term bill may be defined as the end of the tenor of bill.

The date after the tenor ends is called the date of maturity, whereas the date at which the term bill becomes payable by the drawee is called the due date of the term bill. A bill becomes payable by the drawee after the days of grace.

For example, suppose a bill is drawn on 1 January 2019 for three months. Its date of maturity and due date are shown as follows:

Working of Bill of Exchange

How does a bill of exchange work? Let’s explain this with the help of a few examples.

Example 1: Working Without a Bill of Exchange

The situation shown in the figure above can be understood using the following notes:

Now you will see how a bill of exchange helps to promote business activities.

Example 2: Working With a Bill of Exchange

The following points are noteworthy in relation to this figure:

This example shows how a bill of exchange helps to promote business activities.

Advantages of Bill of Exchange

The use of bills of exchange as a method of payment has several advantages compared to other methods of payment for the credit sale of goods. Some of these advantages are the following:

1. Legal evidence
A bill of exchange is a legal document; therefore, it is a legal evidence of the debt. As such, the drawer can sue for the recovery of the amount of the bill.

2. Specific amount and date
A bill of exchange is signed by both parties. For this reason, both parties are aware of the amount of the bill and its due date.

3. Discounting facility
Another advantage of a bill of exchange is that it can be discounted if the drawer or holder needs funds before the due date. The bill can be sold to the bank to receive the total amount in advance.

4. Negotiable
Negotiable means transferable. A bill of exchange payable to the bearer can be transferred by one person to another for the settlement of debt.

5. Drawee enjoys full credit period
The drawee is bound to pay the amount of the bill on the due date. They cannot be compelled to make the payment earlier. Therefore, the drawee enjoys the full credit period.

6. Change in relationship
Before a bill of exchange, the seller is a creditor and the buyer is a debtor. The bill of exchange converts this relationship into “drawer” and “drawee”.

7. Easy remittance
As bill of exchange is a negotiable instrument, just like a postdated cheque. Therefore, it can easily be remitted from one place to another, just like a cheque.

Two Aspects of Bill of Exchange

Earlier, it was mentioned that creditors (sellers) can draw a bill of exchange and become drawers. Since the amount of the bill is receivable by the drawer, the bill of exchange, from this point of view, is called the bill receivable.

On the other hand, the debtor (buyer) accepts the same bill and becomes the drawee. The amount of the bill is payable by drawee, and so from the drawee’s point of view, the bill of exchange is known as the bill payable.

Do you want to test your knowledge about Bill of Exchange? Take the Multiple Choice Questions we have prepared for you here.

Frequently Asked Questions

What is meant by the collection of bills?

To send money or goods to someone else through somebody called as «collector». This person will receive the money or goods and deliver it to the intended person. The collector usually charges a fee which is called ‘commission’.

What is a bill of exchange?

A Bill Of Exchange is an unconditional order in writing, addressed by one person (the drawer) to another (the drawee), signed by the drawer, requiring the drawee to pay on demand a certain sum in money to, or to the order of, a certain person (the payee). All bills of exchange must contain a definite date on which they become due.

When does a bill first come into existence?

A bill first comes into existence when it is signed by the drawer and accepted by the drawee.

What is the difference between a bill and a cheque?

The main difference between a bill and a cheque is that a Bill Of Exchange is not payable on demand, whereas a cheque is. A bill becomes payable at some future date which is fixed when the bill is drawn, whilst a cheque is payable at once. A cheque must always be signed by the drawer, whereas a bill may be signed by the drawer or by someone else on the drawer’s behalf. Bills are also more formal than cheques and are used for transactions which involve larger sums of money.

How does a bill become payable?

A bill becomes payable at the maturity date, which is always specified on the bill. A Bill Of Exchange which becomes payable on a certain day is known as a ‘dated’ or ‘specific’ bill. Bills may also become payable after a certain period following the date of the bill has elapsed, known as an ‘open’ or ‘uncertain’ bill.

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About the Author
True Tamplin, BSc, CEPF®

True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.

True is a Certified Educator in Personal Finance (CEPF®), a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.

To learn more about True, visit his personal website, view his author profile on Amazon, his interview on CBS, or check out his speaker profile on the CFA Institute website.

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Bill of Exchange

Definition

Bill of exchange is the unconditional order in writing which issue by the seller to instruct the buyer to pay a specific amount on demand at an exact time in the future. The most common type of bill of exchange is Cheque, and it will be payable on demand of the drawer after the effective date.

Features of Bill of Exchange

Parties involve in Bill of Exchange

Besides the common cheque, bill of exchange is mostly used for the international trade where the buyer and seller use the bank as the guarantee.

Why Bill of Exchange Exist?

In our normal business operation, the buyer pays cash after receive goods or services, it is easy and simple. However, due to the business expansion, some buyers may request credit terms as they need to resell the goods to final consumers. So they want to receive goods and make payments later because they do have enough money to pay in advance. This kind of customer will buy in a large quantity as they are the middle men who has high bargaining power. If the sellers reject this term, they are highly likely to lose the customers. On the other hand, the seller will risk uncollectible debt if they agree on the term.

It will be riskier if the buyers are living in other countries. At the same time, the buyer also facing the risk if he decides to make payment before accepting the goods. The seller may not ship the goods and he ends up being cheated.

Due to the difficulties of both parties, Bill of Exchange is created in order to solve the problem. The buyer will liable only after receive goods and the seller will have enough evidence to claim payment.

Format of Bill of Exchange

Bill of Exchange Journal Entry

Journal Entry for both seller and buyer: Both drawee and drawer must make the following entry at each stage of transaction.