The commercial bill, or how to secure a business relationship

Believe it or not, the concept of the bill of exchange dates back to the 12th century! In those dangerous times, the Knights Templar devised a way for merchants to make payments in neighbouring territories without having to carry cash (thus avoiding ambushes).

Today, although its purpose has changed considerably, this type of document remains ubiquitous in commercial transactions. A closer look at the bill of exchange.

Understanding the bill of exchange

A few preliminary points

Several parties may be linked to one another through a bill of exchange, and before fully understanding this concept, it is important to be familiar with the following terms:

• The drawee (also known as the debtor) is the party to whom the payment order is addressed. In most cases, this will logically be the customer receiving the goods and/or services.

• The drawer (also known as the creditor) is the party who instructs the drawee to pay the amount owed. The drawer may also be the payee, but this is not always the case.

• The payee (also known as the beneficiary) is the party who will ultimately receive the payment due. In a three-party commercial transaction, the payee will be different from the drawer.

• An intermediary generally refers to a financial institution (mainly a bank) engaged by the payee in certain specific cases.

Definition

A bill of exchange is a document that allows the drawee (debtor) to undertake to honour payment on a due date agreed between the two parties at the time of the transaction.

This negotiable instrument guarantees the payee payment for their work within an agreed timeframe, helping to ensure sound cash flow management.

Because a bill of exchange is not, in itself, tied to any bank account, this document can be transferred (exchanged or assigned) to a payee (final beneficiary) other than the drawer (the party who issued the payment order).

Please note: To be valid, a bill of exchange must be drawn up with the utmost rigour!

Benefits

Using a bill of exchange offers numerous benefits to each party involved:

• the drawee benefits from a grace period before the amount owed is debited, giving them greater flexibility in managing their cash flow;

• the drawer (where they are also the payee) benefits from a guarantee of payment on the due date, which likewise enables better cash flow management through greater visibility;

• the payee may also ask their bank to provide an advance on the drawee’s payment, so as not to have to wait until the agreed due date. In this case, the beneficiary makes use of a bank discount.

At the same time, a bill of exchange carries reassuring legal weight in the event of a commercial dispute, since it sets out the payment terms in a rigorous, formal manner.

Using the bill of exchange

Payment process

The first step, required in any scenario involving a bill of exchange, is acceptance of payment. This is when both the due date and the amount owed by the debtor are set.

The other essential step in processing a bill of exchange is the one that closes the process, namely collection. At this point, the amount owed by the drawee is credited to the beneficiary’s bank account.

Please note: Unlike a bank discount, collection means it is genuinely the debtor’s own money that is transferred to the payee’s account.

The optional step of bank discounting, meanwhile, does involve the amount owed by the drawee being paid in advance into the beneficiary’s account, but these funds come from the bank. In other words, the drawee has not yet been debited; that only happens on the due date agreed by both parties.

In practical terms, bank discounting is a mechanism whereby the beneficiary’s bank buys their bills of exchange from them. In exchange for this cash advance, the bank is remunerated through interest and fees (discount charges).

When the beneficiary assigns their bills of exchange to the bank, they automatically become the assignor. The debtor, for their part, becomes the assigned party. From that point on, the bank becomes the creditor (drawer) of the assigned party.

Finally, the drawer is not always the beneficiary of a bill of exchange. This is particularly the case when the drawer transfers their means of payment to a third party: this is known as endorsement. The third party then becomes the payee of the transaction.

Please note: Before cheques became crossed (non-endorsable), endorsing cheques was regarded as a means of tax evasion. This was because the payee had no knowledge of either the issuer’s identity (the drawer) or the original reason for the payment.

Types of bills of exchange

Today, three main forms of bill of exchange are recognised:

• The Bill of Exchange (draft). This document is issued by the drawer, who instructs the drawee (a customer or a bank) to pay them a predefined amount on a due date set in advance.

• The Promissory Note. This document is issued by the drawee, who thereby takes the initiative in setting the payment due date owed to the drawer. This option gives the customer greater flexibility in determining the timeframe within which they will be able to honour their payments.

• The Cheque. Although it can be cashed at a later date, the cheque is a less secure option, since it allows the creditor to cash it immediately, without regard to any agreed due dates.

The bill of exchange is ideal for helping each party manage their cash flow effectively as part of a commercial exchange.

That said, the rules to be followed are strict and can become even more complex for international transactions. To limit the costs arising from exchange rate risk, discover the b-sharpe solutions available to you!