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). 

Although the purposes of these documents have changed considerably over the years, they remain ubiquitous in commercial transactions. Let’s take a closer look at the commercial bill of exchange.

Understanding the commercial paper

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 these various terms:

• The drawee (also known as the debtor) is the party to whom the payment order is addressed. In many cases, this will naturally be the customer for whom the goods and/or services have been provided.

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

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

• An intermediary generally refers to a financial institution (mainly banks) engaged by the holder in specific circumstances.

Definition

A bill of exchange is a document whereby the drawee (debtor) undertakes to honour the payment on a specified due date, agreed between the two parties at the time of the transaction.

This negotiable instrument guarantees the holder payment for their work within the agreed timeframe, thereby ensuring effective cash flow management.

Because a bill of exchange is not, in itself, linked to any bank account, this document can be transferred (exchanged or shared) to a holder (final beneficiary) other than the drawer (the party issuing the payment order).

Please note: To be valid, the procedure for issuing a bill of exchange must be carried out with the utmost care!

Benefits

The use of a commercial bill offers numerous advantages to each party:

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

• the drawee (where applicable) benefits from a guarantee of payment on the due date, which also enables them to manage their cash flow more effectively by providing greater visibility;

• The bearer may also ask their bank to provide an advance against the drawee’s payment, so as not to have to wait until the stipulated due date. In this case, the beneficiary will make use of a bank discount.

At the same time, a promissory note provides legal certainty in the event of a commercial dispute, as it strictly sets out the terms of payment.

Using a commercial bill

Payment process

The first step (which is essential in any scenario involving the use of a bill of exchange) is the acceptance of payment. The due date is then determined, as is the amount owed by the debtor.

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

Please note: Unlike a bank discount, in this case the collection process involves the debtor’s own funds being transferred to the holder’s account.

The optional step of bank discounting, on the other hand, does indeed involve the sum owed by the drawee being paid in advance into the payee’s account, but this sum comes from the bank’s own funds. In other words, the drawee’s account is not yet debited; this will only take place on the due date agreed by both parties.

In practical terms, bank discounting is a mechanism whereby a bank purchases commercial paper from the beneficiary. In return for this cash advance, the bank is remunerated through interest and fees (discount charges).

When the beneficiary assigns their commercial paper to the bank, they automatically become the assignor. The debtor, for their part, is referred to as the assignee. From that point on, the banker becomes the creditor (drawer) of the assignee.

Finally, there may be cases where the drawer is not the beneficiary of the bill of exchange. This is particularly the case when the drawer transfers the instrument to a third party: this is known as endorsement, whereby the third party becomes the bearer of the bill.

Please note: Before cheques became non-negotiable (non-endorsable), cheque endorsement was regarded as a means of tax evasion. This was because the bearer was unaware of either the identity of the issuer (drawer) or the original reason for the payment.

Types of commercial paper

Today, there are three main types of commercial paper:

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

• The Promissory Note. This document is issued by the drawee, who then takes the initiative in setting the payment due date for the drawer. This option offers the customer greater flexibility in determining when they will be able to honour their payments.

• Cheques. Although they can be cashed at a later date, cheques are a less secure option as they allow the creditor to cash them immediately, and therefore without adhering to the agreed payment terms.

A promissory note is ideal for enabling each party to manage their cash flow effectively when making a payment. 

However, the rules to be followed are strict and can become even more complex when it comes to international transactions. To minimise costs arising from exchange rate risk, discover the b-sharpe solutions available to you!