Bill of exchange is a type of negotiable instrument in which a written, unconditional order made by one party (drawer) is transferred to another (the drawee) to pay a certain sum of money, either immediately or on a fixed date as mentioned in the bill, for payment of goods or services received. Drawee by signing the bill accepts it and this makes the bill a post dated check. Hence a binding contract is formed.
In bill of exchange, there are three parties:-
- Drawer – Drawer is the person who draws or makes the bill of exchange.
- Drawee– Drawee includes the person upon whom the bill of exchange is drawn.
- Payee– Payee is that person to whom payment is to be made.
HOW A BILL OF EXCHANGE FUNCTION
In order to explain the procedure, I would take help of an example. It will simplify the process and will make the understanding of process better.
Ram sells goods worth Rs. 1000 to Mr. Shyam. Now the most common means to make payment for the goods will be cash. But in actual practice payment by this mean i.e. cash is rear. Most of the businessmen’s carry on their trade on credit. Thus to avoid risk, Mr. Ram draws a bill for Rs. 1000 on Mr. Shyam and forwarded the same to Shyam together with goods with an instruction to accept the same. Mr. Shyam was required to sign the bill and return it back to Ram. By signing the bill Shyam approves the bill and also binds himself to pay the amount when become due. On maturity it is presented before the drawee and payment is received.
DISCOUNTING OF A BILL OF EXCHANGE BY BANK
If the drawer of the bill of the exchange needs urgent money before the due date of the bill, he has an alternative to sell it to some bank. Now the bank (buyer) will provide cash in consideration of the bill by deducting some amount. This process is known as discounting of the bill. “Discount” is the amount that is deducted by the bank from the face value of the bill. This amount is usually calculated at a certain rate p.a. determined by the bank authorities.
BILL OF EXCHANGE CAN BE TRANSFERRED (NEGOTIABLE INSTRUMENT)
Bill of exchange is a negotiable instrument. Whenever a bill of exchange is transferred from one person to another person, it is mandatory for the person on whose hands it passes to write his name on the back of bill so as to constitute the transferee of the holder of the bill. This entire process is called ‘endorsement of the bill of exchange’.
BILL OF EXCHANGE WHEN DISHONOURED.
When the drawee refuses to accept the bill when presented before him or refuses to make payment on due date or maturity, bill of exchange is said to be dishonoured.
- Dishonor by non-acceptance means if a drawee refuses to accept the bill when it is presented before him for acceptance. In such cases, an immediate right of recourse against the drawer of bill is formed in favor of holder of the bill.
- Dishonor by non- payment means if the drawee has accepted the bill when presented but on due date or maturity if refuses to make payment. In such cases the holder of bill has immediate right of recourse against each party to the bill.
In short, it can be used as legal evident of debt. This method makes convenient transfer of the debt. Moreover it can be discounted before due date. On other hand, there are disadvantages too. The business man cannot depend upon it as it is short term finance and complete dependence on it will be disastrous for the company. Discounting of bill reduces the amount of bill and there is always a burden on the bank because risk of debtors paying the bill is less.