If you are selling in an international transaction, the bill of exchange might be a practical way to get paid while retaining flexibility and bearing a reasonable risk.
Bill of exchange: almost like cash
A bill of exchange is a financial instrument that incorporates the obligation of one party to pay money to another one. Because it is transferable, a bill of exchange is treated as cash.
However, the difference with cash is twofold: on one side, the buyer has still to comply with his obligation to pay, and, second, he might have some time to do so (time bills, opposed to sight bills that are payable on presentation).
The advantage for the seller is that he can cash the bill of exchange by selling it at a discount to a third party, such as a financial institution.
For example, a credit of USD 100,000 in the form of a bill of exchange could be immediately converted into USD 95,000 in cash by the seller at his bank. In such case, the seller can immediately realise cash from his credit even before the deadline set for the buyer to pay.
Sellers beware: you are still liable
The drawback of the bill of exchange is that the seller is not completely relieved from the buyer’s inability to pay: in fact, whilst the primary liability remains on the buyer, the seller could be also held responsible in case the buyer dishonors the bill and refuses or is unable to pay. In such circumstance, even after having discounted the bill of exchange to a third party, the seller remains liable if the third party has accepted the bill in good faith, i.e. they expected the buyer to comply with his obligations to pay.
How to draw a bill of exchange
A bill of exchange is drafted in the following way: a drawer draws a bill of exchange on a drawee in favor of a payee, who can be a third party, the bearer, the drawer himself.
Suppose that Alpha sells USD 50,000 of merchandise to Beta, payable in 30 days.
Alpha will write a bill of exchange on Beta that obliges the latter to pay the sum of USD 50,000, within 30 days from the date in the document, to either Alpha or the bearer, i.e. whoever will be in possess of the document.
In order to be valid, the bill of exchange must be accepted by the buyer, i.e. the bill drawed by Alpha will become effective only upon acceptance by Beta.
Example 1 (payable to the seller)
1 October 2020
30 days after date pay to our order the sum of fifty thousand dollars, value received.
USD 50,000
Alpha
To: Beta
Example 2 (payable to the bearer):
1 October 2020
30 days after date pay to bearer the sum of fifty thousand dollars, value received.
USD 50,000
Alpha
To: Beta
Advantageous, but still risky
The bill of exchange has the great advantage of allowing the seller to realize cash immediately without getting into more complex transactions such as a letter of credit.
However, due to the fact that a) the seller will have to sell at a discount, and b) the seller does not free himself completely from the risk that the buyer defaults on his due payment, the bill of exchange is not the best payment method in an international sale transaction where the parties are not familiar with each other.
Globartis Research
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