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:
- 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.
A bill of exchange normally includes the following information:
- Title. The term "bill of exchange" is noted on the face of the document.
- Amount. The amount to be paid, expressed both numerically and written in text.
- As of. The date on which the amount is to be paid. Can be stated as a certain number of days after an event, such as a shipment or receipt of a delivery.
- Payee. States the name (and possibly the address) of the party to be paid.
- Identification number. The bill should contain a unique identifying number.
- Signature. The bill is signed by a person authorized to commit the drawee to pay the designated amount of funds.
Issuers of bills of exchange use their own formats, so there is some variation from the information just noted, as well as in the layout of the document.
A bill of exchange is transferable, so the drawee may find itself paying an entirely different party than it initially agreed to pay. The payee can transfer the bill to another party by endorsing the back of the document.
A payee may sell a bill of exchange to another party for a discounted price in order to obtain funds prior to the payment date specified on the bill. The discount represents the interest cost associated with being paid early.
A bill of exchange does not usually include a requirement to pay interest. If interest is to be paid, then the percentage interest rate is stated on the document. If a bill does not pay interest, then it is effectively a post-dated check.
If an entity accepts a bill of exchange, its risk is that the drawee may not pay. This is a particular concern if the drawee is a person or non-bank business. No matter who the drawee is, the payee should investigate the creditworthiness of the issuer before accepting the bill. If the drawee refuses to pay on the due date of the bill, then the bill is said to be dishonored.
A bill of exchange issued by a person may be called a trade draft. If the document is issued by a bank, it may be called a bank draft.