Commercial Bill

Published Apr 6, 2024

Definition of Commercial Bill

A commercial bill, also known as a bill of exchange, is a financial document created by a debtor promising to pay a specified amount of money to the creditor at a predetermined future date or on demand. Commercial bills are typically used in international and domestic trade to finance transactions in goods and services, providing a convenient and secure method of short-term financing.

Example

Imagine a manufacturer of electronic parts, Company A, sells goods to Retailer B on credit terms. To ensure liquidity and maintain its cash flow, Company A needs to get paid as soon as possible, whereas Retailer B wants to delay payment until it sells the goods to its customers. To solve this dilemma, Company A draws up a commercial bill payable in 90 days, allowing Retailer B to pay later while enabling Company A to sell the bill to a bank at a discount for immediate cash. The bank then collects the full amount from Retailer B at the bill’s maturity.

This instrument benefits all parties involved: Retailer B gets credit, Company A maintains liquidity, and the bank earns money from the discount.

Why Commercial Bills Matter

Commercial bills play a critical role in the global economy by facilitating smooth and efficient trade between companies and countries. They offer a cost-effective way of raising short-term finance, thereby enabling businesses to manage their cash flows more effectively without needing to tie up capital for lengthy periods. By helping businesses optimize their operations, commercial bills indirectly contribute to economic growth and stability. Furthermore, because these bills are negotiable instruments, they can be bought, sold, or used as collateral, thus providing financial flexibility to both issuers and holders.

For financial institutions, commercial bills offer an attractive investment option with relatively low risk due to the short maturity and self-liquidating nature of these instruments.

Frequently Asked Questions (FAQ)

How do commercial bills differ from other types of financial instruments?

Commercial bills are short-term, negotiable debt instruments mostly used in trade finance for transactions between businesses. Unlike bonds, which are long-term debt securities, commercial bills typically have maturities of less than a year. Additionally, compared to promissory notes, commercial bills involve three parties (the drawer, the drawee, and the payee) and are usually endorsed or guaranteed, thereby offering more security to the lender or investor.

Can commercial bills be extended or rolled over?

Yes, in some cases, the maturity of a commercial bill can be extended or rolled over, subject to agreement by all parties involved. This can happen when the drawee needs more time to make the payment. However, such extensions may affect the discount rate or interest applied to the bill, reflecting the increased duration of the loan.

What happens if a commercial bill is not paid on its due date?

If a commercial bill is not honored on its maturity date, it is considered to be in default. The holder of the bill can demand payment from the endorser or from any other party that has guaranteed the bill. This legal recourse is one of the reasons why commercial bills are considered relatively secure. In practice, a default on a commercial bill can lead to legal action and potentially damage the defaulter’s credit rating and relationship with banks and suppliers.

Are commercial bills only used in international trade?

No, while commercial bills are widely used in international trade to finance imports and exports, they are also used domestically. In both contexts, they serve as a tool for managing cash flow and financing transactions, although the specific regulations and conventions might differ between domestic and international use.

In summary, commercial bills are an essential financial instrument that supports trade and liquidity in the economy. They provide businesses with a mechanism to finance their operations smoothly, thereby facilitating economic activity and growth.