What is Bill of Exchange? | Definition, Working, Pros and Cons

Exchange of goods can be done for cash or on credit. When goods are traded on credit, the payment is made on a deferred date. In such cases, the seller may either trust the buyer with a verbal promise or may use an instrument of credit to prevent any further delay of payment from the deferred date already fixed.

A Bill of Exchange is one of the many instruments of credit available in the market. According to “Indian Negotiable Instruments Act 1881”, a bill of exchange is a negotiable instrument in writing that comprises an unquestionable order duly signed by the maker. The order directs a particular person (buyer) to pay the creditor or the person mentioned therein or bearer of the instrument a specific amount of money.

Parties in a Bill of Exchange

There are generally three parties in a Bill of exchange:

  1. Drawer: It refers to the creditor or seller who issues the bill.
  2. Drawee: It stands for the buyer or debtor on whose name the bill is issued.
  3. Payee: It refers to the person mentioned by the creditor in the bill to whom the amount is to be paid.

How does Bill of Exchange work?

A Bill of Exchange is used in both domestic and international trade. When they are used in domestic transactions, they are termed as drafts.

However, it must be noted that the Bill of Exchange is primarily used in international trade. In fact, it originated to settle international transactions. While Arab Merchants of the eighth century CE are credited with using similar negotiable instruments, the bill in its current form is attributed to the Lombards of the thirteenth century Northern Italy.

The drawer extends the bill to the drawee who then signs and puts an official stamp on the instrument as a mark of acceptance. As a result, the bill transforms into a negotiable instrument ready to be traded in the market.

The creditor can now deduct this instrument and convert it into cash by extending a bank or a company with a commission. This commission is known as the discount. The bill may change several hands before the due date of payment finally arrives, and the debtor or drawee pays the due amount according to the agreement.

Advantages of Bill of Exchange

The Bill of Exchange has several benefits to make it worthy of usage in domestic and international transactions.

  1. It converts the informal relationship between the creditor and the debtor into a formal one as it provides a legal framework under which the said parties transform into the ‘drawer’ and ‘drawee,’ respectively. Consequently, in conflict situations between the parties, a court of law can be approached to settle the matter.
  2. A Bill of Exchange comprises of the minutest of details regarding the terms and conditions of the payment. These include the amount, date and place of the payment and the interest amount, if applicable. Consequently, the drawee can prepare themselves in advance by arranging for the funds before the due date’s arrival.
  3. It benefits both the creditor and the debtor as the latter can make the payment on a deferred date and the former can discount the bill and get the immediate price even after extending the credit.
  4. Debts are effortlessly transferred under the Bill of Exchange as mere delivery or endorsement is sufficient.
  5. It provides financial help to both the creditor and the debtor by accommodating their mutual benefits.

Disadvantages of Bill of Exchange

Despite being one of the most commonly used credit instruments, Bills of Exchange are not without their share of limitations.

  1. Its usage must be limited to short-term services.
  2. It is deemed as an unsuitable option by the banking services.
  3. The drawee is bound by law to pay the dues before or on the due date of payment.
  4. The drawee has to bear an additional burden if a bank or firm discounts the bill.

Riferimenti

  1. https://www.journals.uchicago.edu/doi/pdfplus/10.1086/252472
  2. https://www.jstor.org/stable/1329536
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