What is Bill of Exchange? – Definition
A bill of exchange is “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”
Key Points of the definition
For a better understanding of the definition of bill of exchange, the following points should be kept in mind:
Bearing no condition means there is no condition attached to the bill.
A bill of exchange is an order to pay certain money. It is not a request.
The person who makes (writes) the bill. He is the person who orders to pay the amount of the bill. He is called drawer
The person upon whom the bill is drawn or the person to whom the order is given. He is known as drawee. He accepts the bill by writing the word “Accepted” across the face of the bill and signing the bill.
It is payable whenever the amount of the bill is demanded. (In case of sight bill only).
A determined time in the future for example on 10th December 2019.
Determinable Future Time:
A future time that can easily determinable for example 90 days after the date of bill drawn.
Certain Sum in Money:
The amount of bill is payable in the form of money rather than a kind or commodity. For example $10000.
Payee is a person to whom the amount of 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. That’s why definition contains the phrase” to or to the order of the specified person or to the bearer”.
In this modern age of competition credit selling is that evil which has to be done by every businessman. Because credit sales is one of the strongest tools that enhance the amount of net income. Refusal to give credit means that potential sales would go to competitors. But no businessman wants to sell goods on credit to those customers who may not pay their debts.
Firstly a businessman wants to promote sales and secondly he wants to secure his money and customers. A seller wants to realize the amount of goods sold as soon as possible, so that the amount of goods sold can be utilized in business and on the other hand chances of bad debts can be minimized. But on the other hand, a buyer wants to get maximum credit period. Is there any method that satisfies both the parties? The answer is yes.
There is a method of payment that provides the seller an evidence of amount receivables as well as amount of goods sold when he desires. This method also sufficient credit period to the buyer well. This method of payment is known as bill of exchange, which has certain advantages over other methods of payment.
Specimen/Format of Bill of Exchange
Parties to a Bill of Exchange
There are three parties involved in a bill of exchange drawer, drawee and payee.
He is the maker of the bill. He is the person who draws or writes the bill. He signs-the bill. However a bill can be accepted before the signature of the drawer, but the signature of the drawer is necessary to complete the document.
He is the person upon whom a bill of exchange is drawn or he is the person who accepts the bill and promises to pay the amount of the bill. When drawee accepts the bill he becomes acceptor.
Payee is the person who is named in the instrument to whom or to whose order the amount of the bill is directed to be paid. He is the person who receives the amount of the bill. He may be drawer himself or someone else. If the drawer keeps the bill with himself till the due date and receives the amount of the bill, then drawer and payee are the same person.
There are also some other parties in a bill of exchange such as:
- Holder in due course
- Drawee in case of need
- Acceptor for honor
The Holder of the Bill
The holder of a bill of exchange is a person who is entitled in his own name to the possession of the instrument and to receive the amount due thereon. Not only possession but it is entitlement to possession that makes a person “Holder of the bills”. 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 bearer is known “Holder in Due Course”. Amy person who has received the bill from the previous holder is called holder in due course.
Drawee in case of need
Sometimes, in bills of exchange, the name of a third person is mentioned; if 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 “Drawee in case of Need”.
Acceptor for honor
If original drawee refuses to 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 of the bill. Such a person is known as “Acceptor for Honor”.
Types of Bill of Exchange
A bill of exchange can be classified on the following three bases:
1. On the basis of time period;
- Demand Bill of Exchange
- Term Bill of Exchange
2. On the basis of objective:
- Trade Bill of Exchange
- Accommodation Bill of Exchange
3. On the basis of territory:
- Inland Bill of Exchange
- Foreign Bill of Exchange
Demand Bill of Exchange
It is a bill that has no fixed date for the payment. It is payable at the time when it is presented by
the holder. Days of grace are not allowed on demand bill. Demand bill is also known as sight bill.
Term Bill of Exchange
It is a bill which is drawn for a specific time period. This type of bill has either fixed future date or determinable future time.
Trade Bill of Exchange
A trade bill of exchange is drawn and accepted as a result of 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
Accommodation bill is drawn and accepted without sale and purchase of goods. The main purpose of such bill is to provide financial assistance to one or both the parties. This bill does not come into existence due to any trading activity.
Inland Bill of Exchange
It is a bill that is drawn, accepted and payable in the same country. Actually, the drawer and acceptor of this bill live in the same country.
Foreign Bill of Exchange
A bill which is drawn in one country and accepted and payable in another country is called a foreign bill of exchange. Actually, drawer and drawee of this bill are the residents of two different countries.
Acceptance of Bill of Exchange
The drawee is not liable to pay the bill until he accepts the bill. Therefore, acceptance by the drawee 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 drawee.
Types of Acceptance
Acceptance is of the following two kinds:
- General Acceptance
- Qualified Acceptance
If the bill of exchange is accepted without any condition to the order of the drawer the acceptance is termed as general 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 of five types which are as under:
i) Qualification as to time
ii) Qualification as to place
iii) Qualification as to partial payment
iv) Qualification as to parties
v) Qualification as to the condition
Tenor of the Bill of Exchange
The time period after which a bill of exchange is matured is called “Tenor” of the bill.
If a 90 days bill is drawn and accepted. The bill will be matured after 90 days. So tenor of this bill is 90 days.
Days of Grace
In 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 is that period of time for the payment of the biil which is fixed by the tradition of the market.
A 90 days bill will be matured after 90 days, therefor tenor of the bills is 90 days. But three extra days will be given to the drawee for payment of the bill. Here “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 is ended is called date of maturity whereas the date at which the term bill becomes payable by the drawee is called due date of the term bill. A bill becomes payable by the drawee after the days of grace.
Suppose a bill is drawn on 01-01-2019 for three months. Its date of maturity and due date will be calculated as under:
Working of Bill of Exchange
How does a bill of exchange work? It can be explained with the help of the following demonstrations.
Situation without the use of Bill of Exchange
Notes to figure
The situation shown in above figure can be understood with the help of the following notes:
i) Business activities are stopped because Mr. John the retailer has no money to buy goods. For his shop, on the other hand, David & Co. the manufacturer wants to sell goods for cash only.
ii) The problem can be solved if somehow goods are provided to the retailer on credit and the manufacturer is also paid immediately for his goods.
iii) A bill of exchange accepted by a reputed businessman is also an acceptable document for the bank. Bank will easily land money to the holder of the bill.
Now you will see how a bill of exchange helps in promoting business activities.
The situation with the use of bill of exchange
Notes to figure
i). David & Co. the manufacturer, Sells goods on Credit to Mr. John The retailer. Retailer accepts a bill for the amount. David gets the bill discounted and fulfills his cash needs.
ii). Now retailer has stock of goods to sell. Customer can buy goods from retailer. He will pay the amount of the bill after three months.
iii). Bank discounts the bill and earns interest revenue of $2500.
This is how a bill of exchange helps to increase business activities.
Advantages of bill exchange
Bill of exchange method of payment has certain advantages over the other methods of payment for credit sale of goods. Some of these advantages are as under.
1. Legal evidence
Bill of exchange is a legal document; therefore it is a legal evidence of the debt. Drawer can sue for the recovery of the amount of the bill.
2. Specific amount and date
Bill of exchange is signed by both the parties. So both the parties are well aware regarding amount of the bill and due date of the bill.
3. Discounting Facility
Another advantage of bill of exchange is that it can be discounted if drawer or holder of the bill is in need of money before the due date of the bill. He can sell the bill to bank to get the amount of the bill in advance.
Negotiable means transferable. A bill of exchange payable to bearer can be transferred by one person to another for the settlement of debt.
5. Drawee enjoys full credit period
Drawee is bound to pay the amount of the bill on the due date. He cannot be compelled to make payment earlier. Therefore he enjoys full credit period.
6. Change in relationship
Before bill of exchange seller is a creditor and buyer is a debtor. Bill of exchange converts this relation 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
It has been mentioned earlier that creditor (seller) draws a bill of exchange and becomes “Drawer”. Since the amount of the bill is receivable by him, therefore from his point of view this bill is called “Bill Receivable”.
On the other hand, debtor (buyer) accepts the same bill and becomes “Drawee”. The amount of
bill is payable by drawee, therefore from drawee’s point of view this bill is known as “Bill Payable”.