Before we explain the types of bills of exchange, it is good we understand the meaning of a bill of exchange. A bill of exchange is simply a paper that compels a bank or an individual to pay a certain amount of money to another person, company, or country. The person ordering the bank or another individual is called the drawer; while the person to be paid is called the payee, and the person or bank that was ordered to pay the said amount of money to the payee is called the drawee.
There are different types of bills of exchange and each type can be categorized based on the time or period needed to cash the bill of exchange; based on the person or bank issuing it, etc.
Different Types of bills of exchange
There are various types of bills of exchange, they would be listed based on the criteria used in their classification and then each type would be explained.
The types of bills of exchange based on the period of payment
- Demand Bill: this kind of bill of exchange has no fixed date for payment but the payee can cash the draft at any time. The sample of the bank draft shown in this article is an example of a demand bill of exchange. It can be cashed at anytime or date.
- Sight draft: this form of bill of exchange ensures the payment is immediate.
- Term bill: in this type of bill of exchange, the payment is left for a future date; it is not immediate, but rather has a fixed date of payment. It is also known as usance bill.
Classification of a bill of exchange based on the documents provided
- Clean Bill
- Documentary Bill of Exchange
A documentary bill has supporting shipping documents. The bank takes hold of the shipping documents so that the importer or buyer is only given the documents when he makes the payment for the goods or acknowledges that he has received the goods.
If the drawer of the bill (seller) gives an order to the bank to only release the shipping documents to the importer (buyer) when he/she has paid the money for the goods, then this kind of documentary bill of exchange is called Documents against Payment (D/P) Bill.
If the drawer of the bill (seller) gives an order to the bank to only release the shipping documents to the importer (buyer) when he/she has accepted the bill and agreed to make payment according to the fixed date on the bill, then this type of documentary bill of exchange is called Documents against Acceptance (D/A) Bill.
A clean bill refers to any type of bill of exchange that does not have supporting shipping documents. Clean bills are generated with higher fees by banks.
Types of bills of exchange in accounting based on the purpose (objective)
- Accommodation bill
- Trade Bill
Accommodation bill (Kite bill)
A bill made between 2 parties without any trade occurring between the parties is referred to as an accommodation bill (or informally called a kite bill). The main use of an accommodation bill is to offer financial assistance to the debtor. One of the disadvantages of an accommodation bill is that it is not legally binding, or it cannot be legally enforced. This means that the drawee may not honor the bill on the due date and no legal action can be taken. An accommodation bill has no conditions attached to it and it is formed out of strong mutual trust between the two parties. It is sometimes used as a method of raising funds.
A trade bill is a type of international bill of exchange in which a seller draws the bill which is then accepted by the buyer. A trade bill is also called a Trade draft. The buyer agrees to pay the seller at an agreed time and based on some laid down terms. Most times, the trade bill is avalised with the bank of the buyer. An avalised bill of exchange simply means that the buyer’s bank has agreed to guarantee the payment of the amount of money. Guaranteeing a payment by the buyer’s bank gives the seller confidence because even when the buyer absconds or fails to make the payment, the bank of the buyer would have to pay the seller the full amount of money and it is then left for the bank to chase after the buyer. The ability to avalised a trade bill is one of the significances of bills of exchange.
Another importance of a trade bill in international trade is that a fixed amount of money is agreed to be paid for the purchased goods or products irrespective of any future fluctuations in the exchange rate. This again gives confidence to the seller that no matter the time or period agreed upon, the actual amount would be received. This also helps the buyer to avoid paying more in case the exchange rate increases in the future.
The 2 types of bills of exchange based on the drawee
- Trade draft
- Bank draft
When a bill is issued by an individual and not by a bank, it is referred to as a trade draft or trade bill.
A bank draft is a type of bill of exchange in which a bank guarantees payment to a third party by actually confirming that the said amount of money is available in the drawer’s account; the bank then withdraws the money from the drawer’s account together with associated charges or fees into an internal account of the bank. The amount withdrawn from the drawer’s account to the general or internal account of the bank would then be paid into the account of the payee anytime the payee presents the bank draft to the drawer’s bank. In this case, the bank of the drawer is serving as the drawee.
A bank draft is also known as a banker’s check, teller’s check, or bank check.
The advantage of using a bank draft is that it prevents the buyer from carrying a large sum of money to be used for payment. It also helps the seller to collect multiple drafts from different customers over a period of time before going to the bank to cash the bank drafts.
Another advantage of a bank draft is that it enables a transaction to be made between the seller and the buyer before the seller cashes the draft.
Difference between a bank draft and avalised bill of exchange
Before a bank draft is generated for the customer (drawer), the teller must confirm that the requested amount is available in the account of the customer (drawer). This is the difference between an avalised bill of exchange and a bank draft. In both cases, a bank guarantees payment to a third party; but in the case of a bank draft, the amount of money must be available in the bank account of the drawer whereas, in an avalised bill of exchange, the said amount is like a credit granted to the buyer (a customer of the bank that is avalising the bill). Whether the buyer has the amount of money in the account or not, the bank guarantees the payment by avalising it. Once the date is due, the bank makes the payment to the seller. It is now left for the buyer to honor the avalised bill and pay the bank or dishonor the bill and the bank goes after the buyer by taking any necessary legal action.
Types of trade bills
- Inland Bill
- Foreign Bills
An inland bill is a type of trade bill in which the seller and buyer both reside in the same country and therefore, the payment is made within the said country.
Foreign bill (Foreign draft)
A foreign draft or foreign bill involves the parties residing in different countries and in which the payment is made in the buyer’s country.
The advantage of a foreign bill or foreign draft is that it can be used for opening a credit account in a foreign country and the foreign account would be denominated in the local currency, which would then be used for paying the seller. This helps to reduce the cost of sending money to another country with associated exchange fees and bank routing delays. A foreign draft is cheaper and more efficient to make payment than sending the currency itself.
An example of using a foreign draft is a buyer in Canada paying a UK-based seller using a foreign draft. This means the Canadian buyer will use Canadian dollars to draw the draft but the UK-based seller would be paid by his bank in pounds sterling. This is of great help to the Canadian buyer because he would have sourced for Pounds sterling in Canada before making a transfer to the seller in the UK – this would have incurred heavy charges/fees and takes time for the money to be received because of routing delays.
Difference between inland bill and foreign bill
|Inland Bill||Foreign Bill|
|Drawn between two parties within the same country||Drawn between two parties that are in different countries|
|Trading involves using the same currency||Trading involves using different currencies|
|Used for local trades||Used for international trades|
|–||Can be subdivided into an export bill and an import bill|
Other types of bills of exchange
Other types of bills of exchange are worthy to be mentioned.
- Supply Bill: when a supplier draws a bill against a government agency or department, it is called a supply bill.
- Fictitious bill: this is simply a bill that bears fictitious names of both the seller and buyer.
What are the differences between inland bill and foreign bill?
The major difference between inland bill and foreign bill is that an inland bill deals with the parties of the bill located in the same country whereas the parties in a foreign bill are located in different countries.
Which are the two types of bill of exchange?
The two major types of bills of exchange are accommodation bill and trade bill.
How many types of bills of exchange? Mention them.
There are different types of bills of exchange that can be classified as either inland or foreign bill, clean or documentary bill, and accommodation or trade bill.
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