What is a Bill for Collection?

Remay Villaester (May)

When operating in a business involved in importing and/or exporting, there are several financial instruments available. These instruments protect these parties from default risk and foreign exchange fluctuations. Bills for collection or a bill of exchange is one method that provides a seamless settlement to trade by reducing ambiguity related to amount and time of payment.

This article will explain what a bill of exchange is and what flexibility it offers to the parties involved.

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What is a bill of exchange?

A bill of exchange is an instrument issued by the exporter that provides an order for the importer to pay a fixed sum of money on demand or at a predetermined date. Since it is a negotiable instrument, the bill of exchange can be transferred to a third person. In that case, the importer would make payment to the bearer of the bill instead of the original exporter.

A bill of exchange ensures that there is no ambiguity in the payment amount or the time at which the payment is to be made.

A bill of exchange may also accrue interest if it’s not cleared within a specific date. Since it is transferable, it can also be traded at a discount to another party. This enables the exporter to procure funds in advance. Another advantage of a bill of exchange is that traders can proceed with or without the involvement of a third party for intermediation.

Who are the parties involved in the bill of exchange?

In the previous section, the parties were referred to as importers and exporters for ease of understanding. However, terminologies can change in the context of a bill of exchange.

The party writing the bill, generally the exporter, is termed as the payee - the party obligated to make the payment is called the drawee. There may also be a third party involved known as the drawer who acts as an intermediary for enforcing the bill of exchange.¹

The drawer and the payee are the same if the payment is received by the payee. However, if the bill is transferred, the issuer becomes the drawer, and a new payee is involved. The illustration below should make it clear:

Case 1: Party A issues Bill of Exchange and receives payment from Party B

Case 2: Party A issues Bill of Exchange and transfers it to Party C

What does a bill of exchange process look like?

The best way to understand the process is with the help of an example. Consider a European car manufacturer:

  • Car Manufacturer (M) that wants to import steel from a Chinese supplier (S).
  • S will issue a bill of exchange that will outline the amount and the time on which the payment is to be made.
  • S then exports the steel to M.
  • After the stipulated time has passed, S presents the bill to M, and the European manufacturer has to make the payment to S

In this example, S is the drawer and payee while M is the drawee.

Now suppose S wants money in advance. It can transfer the bill of exchange to a third party (T) in exchange for cash. The amount received by S would likely be less than stipulated in the bill of exchange due to discounting. T is now the new payee and can present the instrument to M.

What are the types of bills of exchange?

A bill of exchange can be differentiated based on the entity issuing unit. They are:²

1. Bank Draft: This is issued by a bank that guarantees payment to the payee
2. Trade Draft: If a trading entity issues the bill of exchange, then it is classified as a trade draft

Depending on when the bill can be presented, a bill of exchange can be classified as:

1. Sight Draft: The payment has to be made when the bill is presented to the drawee
2. Time Draft: The payment has to be made at a specific time point mentioned in the bill of exchange. The future date is generally a few days after the importer receives the product.

An accommodation bill is one in which the drawer does not receive any payment from the drawee. The drawer only acts as an intermediary for the transaction to go through.

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Clearing the amounts in a bill of exchange using traditional methods like banks are often expensive especially when currency conversion is involved. This is due to high mark-up on foreign exchange rate.

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Sources used:
  1. Guichet Public Article
  2. Investopedia Article

Last checked on 27 December 2021

This publication is provided for general information purposes only and is not intended to cover every aspect of the topics with which it deals. It is not intended to amount to advice on which you should rely. You must obtain professional or specialist advice before taking, or refraining from, any action on the basis of the content in this publication. The information in this publication does not constitute legal, tax or other professional advice from TransferWise Limited or its affiliates. Prior results do not guarantee a similar outcome. We make no representations, warranties or guarantees, whether express or implied, that the content in the publication is accurate, complete or up to date.

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