It is a binding short-term financial instrument that mandates one party to pay a specific sum of money to another at a predetermined date or on-demand. Also known as a bill of exchange, it essentially denotes, in writing, that one person (debtor) owes money to another (Creditor).
Businesses predominantly use bill finance during international trade, since the degree of uncertainty concerning the payment is considerable in that regard. However, there’s no set law as such, and companies can use a bill of exchange for intra-border trade as well.
Bill finance is a crucial document for businesses that carry out trade on credit. It not only substantiates a transaction, but also provides a legal avenue to creditors, if debtors fail to make good on their debts.
Usually, bill finance does not involve any interest payment. But, a creditor might charge a penalty fee or interest if it does not receive the due amount by a predetermined date. In that case, the issuer must mention these details in such a document.
Bill Finance Working
The practice of bill of exchange issuance involves three parties primarily:
Drawer: This person issues a bill of exchange, usually before undertaking credit sales. A drawee is obliged to pay the due amount to a drawer. This entity must sign a bill of exchange during issuance.
Drawee: This is the person or entity on which a bill of exchange is issued, also referred to as the debtor. A drawee needs to accept the bill, which legally binds it to pay a specific sum.
Payee: The payment ultimately goes to a payee. In most cases, a drawer, and payee are the same entity. However, in some cases, a drawer can transfer bill finance to a third-party, in which case that person becomes the payee.
|Demand bill||Also known as sight draft, this type of bill finance comes with an on-demand payment stipulation.|
|Usance bill||Bills of exchange that feature the clause of payment by a specific date and time. These are also known as time draft.|
|Documentary bill||A type of bill of exchange that requires the presentation of supporting documents attesting to the legitimacy of a transaction(s).|
|Clean bill||It involves no supporting documents, and therefore, the interest that one needs to pay, if any, is much higher.|
|Inland bill||This is issued for transactions within national borders.|
|Foreign bill||As opposed to the inland bill, a foreign bill of exchange is issued to debtors beyond national borders.|
|Bank draft||When a bank issues a bill of exchange, it’s called a bank draft. In this case, a bank enforces bill payment as per terms.|
|Trade draft||Bill finance issued by an individual is called a trade draft.|
|Accommodation bill||It refers to the unconditional bill finances.|
Drawee is a legal and banking term used to describe the party that has been directed by the depositor to pay a certain sum of money to the person presenting the check or draft. A typical example is if you are cashing a paycheck. The bank that cashes your check is the drawee, your employer who wrote the check is the drawer, and you are the payee.
Functions of a Drawee
In a financial transaction, a drawee typically serves as an intermediary. The primary purpose of the drawee is to channel and direct funds from a payer’s account (also known as a drawer or depositor) to the account of the payee (the receiver of the funds or the natural person to whom the funds are payable).
In most instances, the drawee is a financial institution. In such a situation, the drawee holds the funds from the payer in an account that it manages. The account is often a deposit account. It is a common function for consumer and/or commercial banks. The consumer bank takes funds from the account of the payer or depositor to meet the financial obligation set forth in accordance with the information provided on a check.
Apart from banks, other entities that can serve as a drawee can be wire transfer and money order companies and companies that provide check-cashing services. It is important to note that the entities may require processing fees to facilitate and process the transaction to completion. Money orders typically serve as a bill of exchange (the drawee role). In such a transaction, the bill of exchange is presented to the payee and is honored by the entity that receives the funds from the depositor or payer.
A bill of exchange is a binding agreement by one party to pay a fixed amount of cash to another party as of a predetermined date or on demand. Bills of exchange are primarily used in international trade. Their use has declined as other forms of payment have become more popular. There are three entities that may be involved with a bill of exchange transaction. They are as follows:
Drawee. This party pays the amount stated on the bill of exchange to the payee.
Drawer. This party requires the drawee to pay a third party (or the drawer can be paid by the drawee).
Payee. This party is paid the amount specified on the bill of exchange by the drawee.
Discounting is a financial mechanism in which a debtor obtains the right to delay payments to a creditor, for a defined period of time, in exchange for a charge or fee. Essentially, the party that owes money in the present purchases the right to delay the payment until some future date. This transaction is based on the fact that most people prefer current interest to delayed interest because of mortality effects, impatience effects, and salience effects. The discount, or charge, is the difference between the original amount owed in the present and the amount that has to be paid in the future to settle the debt.
The discount is usually associated with a discount rate, which is also called the discount yield. The discount yield is the proportional share of the initial amount owed (initial liability) that must be paid to delay payment for 1 year.
Discount Yield = Charge to delay Payment for 1 Year / Debt Liability
Stakeholders in Bill Discounting
Bill Discounting is made possible by multiple parties working together for a scenario to enable movement of goods.
There are 3 main stakeholders:
Seller is the one who is selling the goods and expects the payment. in case of bill discounting, seller takes the payment from bank earlier than the credit period and gets funds immediately but after a discount which is charges as fee by the bank.
Buyer is the one who is buying the goods and is supposed to make or initiate the payment to the seller through letter of credit. In case of bill discounting the payment is made in full to the bank instead of the seller.
Bank acts as the intermediary in the bill discounting scenario by providing funds immediately to the seller on behalf of buyer within the credit period and collects the full amount from buyer as per LOC terms.
Advantages of Bill Discounting
- It also helps the bank earn some revenue.
- Bill Discounting is a major trade activity. It helps the seller’s get funds earlier on a small fees or discount.
- The borrower or (seller’s) customer can pay money on the due date of the credit period.
Disadvantages of Bill Discounting
- Bill Discounting is not available to everyone especially new businesses.
- It is good for short term financing but is not a long term finance option.