A Commercial Bill is one which arises out of a genuine trade transaction, i.e. credit transaction. As soon as goods are sold on credit, the seller draws a bill on the buyer for the amount due. Commercial Bills: Meaning, Types, and Advantages! The buyer accepts it immediately agreeing to pay the amount mentioned therein after a certain specified date. Thus, a bill of exchange contains a written order from the creditor to the debtor, to pay a certain sum, to a certain person, after a creation period. A bill of exchange is a “self-liquidating” paper and negotiable/it is drawn always for a short period ranging between 3 months and 6 months.
Explain and Learn, Commercial Bills: Meaning, Types, and Advantages!
Meaning of Commercial Bills Market:
The commercial bills are issued by the seller (drawer) on the buyer (drawee) for the value of goods delivered by him. These bills are for 30 days, 60 days or 90 days maturity. If the seller is in need of funds, he may draw a bill and send it to the buyer for the seller is in need of funds, he may draw a bill and send it to the buyer for acceptance.
The buyer accepts the bill and promises to make payment on the due date. He may also approach his bank to accept the bill. The bank charges a commission for the acceptance of the bill and promises to make the payment if the buyer defaults. Once this process is accomplished, the seller can sell it in the market. This way a commercial bill becomes a marketable investment.
Usually, the seller will go to the bank for discounting the bill. The bank will pay him after deducting the interest for the remaining period of the bill and service charges from the face value of the bill. The interest rate is called the discount rate on the bills. The commercial bill market is an important channel for providing short-term finance to business.
However, the instrument did not become popular because of two factors:
- Cash credit scheme is still the main form of bank lending, and
- Big buyers in the corporate sector are still unwilling to the payment mode of commercial bills.
Definition of Bill of Exchange:
“An instrument in writing containing an unconditional order, signed by the maker, directing a certain person to pay a certain sum of money only to, or to the order of a certain person or to the beater of the instrument”.
What is a Bill of Exchange?
According to section 5 of the Negotiable Instruments Act, 1881, defines Bill Of Exchange as,
“A bill of exchange is an instrument in writing containing an unconditional order, signed by the maker, directing a certain person to pay a certain sum of money only to, or to the order of, a certain person or to the bearer of the instrument.”
A promise or order to pay is not “conditional”, within the meaning of this section and section 4, by reason of the time for payment of the amount or any installment thereof being expressed to be on the lapse of certain period after the occurrence of a specified event which, according to the ordinary expectation of mankind, is certain to happen, although the time of its happening may be uncertain.
The sum payable may be “certain”, within the meaning of this section and section and section 4, although it includes future indicated rater of change, or is according to the course of exchange, or is according to the course of exchange, and although the instrument provides that, on default of payment of an installment, the balance unpaid shall become due.
The person to whom it is clear that the direction is given or that payment is to be made may be a “certain person,” within the meaning of this section and section 4, although he is misnamed or designated by description only.
Types of Bills:
Many types of bills are in circulation in a bills market. They can be broadly classified as follows:
Demand and Using Bills:
Demand bills are others called sight bills. These bills are payable immediately as soon as they are presented to the drawer. No time of payment is specified and hence they are payable at sight. Using bills are called time bills. These bills are payable immediately after the expiry of time period mentioned in the bills. The period varies according to the established trade custom or usage prevailing in the country.
Clean Bills and Documentary Bills:
When bills have to be accompanied by documents of title to goods like Railways, receipt, Lorry receipt, Bill of Lading etc. the bills are called documentary bills. These bills can be further classified into D/A bills and D/P bills. In the case of D/A bills, the documents accompanying bills have to be delivered to the drawee immediately after acceptance. Generally, D/A bills are drawn on parties who have a good financial standing.
On the order hand, the documents have to be handed over to the drawee only against payment in the case of D/P bills. The documents will be retained by the banker. Till the payment o0f such bills. When bills are drawn without accompanying any documents they are called clean bills. In such a case, documents will be directly sent to the Drawee.
Inland and Foreign Bills:
Inland bills are those drawn upon a person resident in India and are payable in India. Foreign bills are drawn outside India and they may be payable either in India or outside India. They may be drawn upon a person resident in India also. Foreign boils have their origin outside India. They also include bills drawn on India made payable outside India.
Export and Foreign Bills:
Export bills are those drawn by Indian exports on importers outside India and import bills are drawn on Indian importers in India by exports outside India.
Indigenous bills are those drawn and accepted according to native custom or usage of trade. These bills are popular among indigenous bankers only. In India, they called “Hundis” the Hundis are known by various names such as – Shah Jog, Nam Jog, Jokhani, Termainjog, Darshani, Dhanijog, and so on.
Accommodation Bills and Supply Bills:
If bills do not arise out of genuine trade transactions, they are called accommodation bills. They are known as “kite bills” or “wind bills”. Two parties draw bills on each other purely for the purpose of mutual financial accommodation. These bills are discounted with bankers and the proceeds are shared among themselves. On the due dates, they are paid.
Supply bills are those neither drawn by suppliers or contractors on the government departments for the goods nor accompanied by documents of title to goods. So, they are not considered as negotiable instruments. These bills are useful only for the purpose of getting advances from commercial banks by creating a charge on these bills.
Operations in Commercial Bills Market:
From the operations point of view, the bills market can be classified into two viz.
- Discount Market
- Acceptance Market
Discount market refers to the market where short-term genuine trade bills are discounted by financial intermediaries like commercial banks. When credit sales are affected, the seller draws a bill on the buyer who accepts it promising to pay the specified sum at the specified period. The seller has to wait until the maturity of the bill for getting payment. But, the presence of a bill market enables him to get paid immediately.
The seller can ensure payment immediately by discounting the bill with some financial intermediary by paying a small amount of money called “Discount rate” on the date of maturity, the intermediary claims the amount of the bill from the person who has accepted the bill. In some countries, there are some financial intermediaries who specialize in the field of discounting.
For instance, in London Money Market there are specialized in the field discounting bills. Such institutions are conspicuously absent in India. Hence, commercial banks in India have to undertake the work of discounting. However, the DFHI has been established to activate this market.
The acceptance market refers to the market where short-term genuine trade bills are accepted by financial intermediaries. All trade bills cannot be discounted easily because the parties to the bills may not be financially sound. In case such bills are accepted by financial intermediaries like banks, the bills earn a good name and reputation and such bills can readily discount anywhere.
In London, there are specialist firms called acceptance house which accept bills drawn by trades and import greater marketability to such bills. However, their importance has declined in recent times. In India, there are no acceptance houses. The commercial banks undertake the acceptance business to some extent.
Advantages of Commercial Bills:
Commercial bill market is an important source of short-term funds for trade and industry. It provides liquidity and activates the money market. In India, commercial banks lay a significant role in this market due to the following advantages:
Bills are highly liquid assets. In times of necessity, bills can be converted into cash readily by means of rediscounting them with the central bank. Bills are self-liquidating in character since they have fixed tenure. Moreover, they are negotiable instruments and hence they can be transferred freely by mere delivery or by endorsement and delivery.
The certainty of Payment:
Bills are drawn and accepted by business people. Generally, business people are used to keeping their words and the use of the bills imposes strict financial discipline on them. Hence, bills would be honored on the due date.
Bills are for periods not exceeding 6 months. They represent advances for a definite period. This enables financial institutions to invest their surplus funds profitably by selecting bills of different maturities. For instance, commercial banks can invest their funds on bills in such a way that the maturity of these bills may coincide with the maturity of their fixed deposits.
Simple Legal Remedy:
In case the bills are dishonored, the legal remedy is simple. Such dishonored bills have to be simply noted and protested and the whole amount should be debited to the customer’s accounts.
High and Quick Yield:
The financial institutions earn a high quick yield. The discount is dedicated at the time of discounting itself whereas, in the case of other loans and advances, interest is payable only when it is due. The discounts rate is also comparatively high.
Easy Central Bank Control:
The central bank can easily influence the money market by manipulating the bank rate or the rediscounting rate. Suitable monetary policy can be taken by adjusting the bank rate depending upon the monetary conditions prevailing in the market.
Drawbacks of Commercial Bills:
In spite of these merits, the bills market has not been well developed in India. The reasons for the slow growth are the following:
The Absence of Bill Culture:
Business people in India prefer O.D and cash credit to bill financing, therefore, banks usually accept bills for the conversion of cash credits and overdrafts of their customers. Hence bills are not popular.
The absence of Rediscounting Among Banks:
There is no practice of re-discounting of bills between banks who need funds and those who have surplus funds. In order to enlarge the rediscounting facility, the RBI has permitted financial institutions like LIC, UTI, GIC, and ICICI to rediscount genuine eligible trade bills of commercial banks. Even then, bill financial is not popular.
Stamp duty discourages the use of bills. Moreover, stamp papers of the required denomination are not available.
The Absence of Secondary Market:
There is no active secondary market for bills. The rediscounting facility is available in important centers and that too is restricted to the apex level financial institutions. Hence, the size of the bills market has bee curtailed to a large extent.
Difficulty in Ascertaining Genuine Trade Bills:
The financial institutions have to verify the bills so as to ascertain whether they are genuine trade bills and not accommodation bills. For this purpose, invoices have to be scrutinized carefully. It involves additional work.
Limited Foreign Trade:
In many developed countries, bill markets have been established mainly for financing foreign trade. Unfortunately, in India, foreign trade as a percentage to national income remains small and it is reflected in the bill market also.
The Absence of Acceptance Services:
There is no discount house or acceptance house in India. Hence specialized services are not available in the field of discounting or acceptance.
The attitude of Banks:
Banks are shy rediscounting bills even the central bank. They have a tendency to hold the bills till maturity and hence it affects the velocity of the circulation of bills. Again, banks prefer to purchase bills instead of discounting them.