Definition
A Bill of Exchange is a written financial instrument where one person orders another person to pay a specified sum of money at a future date. This transaction typically involves three parties: the drawer, the payee and the drawee. On the other hand, a Promissory Note is a written promise by one party (the maker or issuer) to pay a specified sum of money to the receiver, either on demand or at a fixed future date. This usually involves two parties: the maker and the payee.
Key Takeaways
- A Bill of Exchange involves a minimum of three parties – the drawer, the drawee, and the payee. The drawer creates the bill and gives it to the drawee to pay a third party (payee). On the other hand, a Promissory Note involves only two parties – the maker and the payee. The maker promises to pay a certain amount to the payee.
- Another distinguishing factor is acceptance. A Bill of Exchange requires acceptance before it is binding. The drawee must agree to pay the amount stated in the bill. However, a Promissory Note is a signed promise to pay, and does not require any acceptance.
- Liability also differs between the two. In a Bill of Exchange, if the drawee fails to pay, the drawer is responsible for payment. With a Promissory Note, the maker is directly liable to the payee.
Importance
Understanding the finance terms: Bills of Exchange and Promissory Notes is significant in international trade and domestic transactions. Both tools offer predetermined methods of payment, but they differentiate in various respects.
A bill of exchange is a written order binding one party to pay a fixed amount of money to another party on demand or at a future date. It involves three parties – the drawer, drawee, and payee.
On the other hand, a promissory note is a written promise wherein the maker commits to pay a specific amount to the payee or to his order at a set time or on demand. It only involves two parties – the maker and the payee.
Understanding these two terms helps businesses maintain financial discipline and make informed decisions with regards to credit transactions, improving their financial management.
Explanation
A Bill of Exchange and a Promissory Note both play significant roles in the realm of finance, particularly in the facilitation of trade and financial transactions. The principal purpose of a Bill of Exchange is to ensure the trustworthiness of the transaction particularly in international trade. It’s a written, unconditional order by one party (the drawer) to another (the drawee) to pay a certain sum, either immediately (sight bill) or on a fixed date (time bill), for payment of goods and/or services received.
This assures both parties involved in the transaction that the payment will be made once the goods or services have exchanged hands. It can be transferred from one person to another and is used primarily in international trade, credit transactions, and to finance the transport of goods. On the other hand, a Promissory Note is essentially a written promise to pay a specified amount of money to a particular individual or bearer at a specified date or on-demand.
Its purpose is to document a loan between two parties, specifying the terms of repayment. It’s often used as a means of getting access to capital or credit, such as in personal loans or business financing, without having to undergo the lengthy and complex process typically associated with bank loans. The use of promissory notes is often preferred in small businesses or between individuals as it provides a simplified method of securing and documenting loans.
As both tools help in ensuring the smooth flow of credit and thus, contribute to the financial stability of businesses, it’s essential to understand their distinctive roles and applications.
Examples of Bills of Exchange vs Promissory Note
Example 1 – Trade Transactions: Suppose a company from the United States, called ABC Corp., purchases goods from a supplier, XYZ Limited, in China. XYZ Limited may issue a Bill of Exchange to ABC Corp., demanding payment by a certain date. This requires ABC Corp. to honour the payment on the said date. Meanwhile, ABC Corp. could issue a Promissory Note to XYZ Limited, guaranteeing payment by that same date. In this scenario, the Bill of Exchange is drawn by the supplier and the Promissory Note by the buyer.
Example 2 – Student Loan: Consider a student who takes out a loan for their education. The lending bank could issue a Promissory Note that the student must sign, promising to pay back the loan amount along with any interest by a certain date. A Bill of Exchange would not typically come into play in this scenario, as the student is not demanding payment from the bank, but promising to make a payment to the bank.
Example 3 – Business Loans: Say a small business owner takes out a loan from a financial institution to expand their operations. The financial institution may require a Promissory Note from the business owner, ensuring repayment of the loan. Alternatively, if the business owner has sold goods or services to a customer who will pay at a later date, the business owner could issue a Bill of Exchange to the customer, requiring payment by the stipulated date. In these examples, the differences between Bills of Exchange and Promissory Notes can be seen – the former is a demand for payment, typically used in trade, while the latter is a promise to pay, often used in loan situations.
FAQs: Bills of Exchange vs Promissory Note
What is a Bill of Exchange?
A bill of exchange is a legally binding document between parties where one party demands payment from another party at a set future date. It’s typically used in international trade and contains explicit instructions about the payment amount and date.
What is a Promissory Note?
A promissory note is a financial instrument in which the issuer promises in writing to pay a specific amount to a specific person at a specific future date or on demand. It’s more of a personal document and doesn’t need acceptance as in case of a bill of exchange.
What are the main differences between a Bill of Exchange and a Promissory Note?
The main differences between a bill of exchange and a promissory note lie in the number of parties involved, the nature of the document, and the need for acceptance. A bill of exchange involves three parties – the drawer, the drawee, and the payee, while a promissory note involves only two parties – the maker and the payee. A bill of exchange also requires acceptance by the drawee, while a promissory note does not.
Is a Promissory Note legally enforceable?
Yes, a promissory note is a legally enforceable financial instrument, provided it complies with the required laws for its validity like it’s signed by the maker, it has a specific amount, payee and a promise to pay either on a specific date or on demand.
When is a Bill of Exchange used?
A bill of exchange is often used in international trade for the purchase and sale of goods, where the buyer and seller may not know each other personally. It’s a way of ensuring that the buyer will pay the agreed amount on the specified date or on demand.
Related Entrepreneurship Terms
- Drawer vs Maker: In a bill of exchange, the party that creates the bill is known as the “drawer,” while in a promissory note, the party that creates the note is referred to as the “maker.”
- Three Parties vs Two Parties: A bill of exchange involves three parties – the drawer, the drawee, and the payee. But a promissory note involves only two parties – the maker and the payee.
- Unconditional Order vs Unconditional Promise: A bill of exchange is an unconditional order to pay a certain amount, whereas a promissory note is an unconditional promise to pay a certain amount.
- Acceptance: A bill of exchange requires acceptance – the drawee must agree to pay the amount. In contrast, a promissory note, being a promise, does not require any acceptance.
- Stamp Duty: Bills of exchange and promissory notes both involve stamp duties, but the application and charges may vary in different situations and places according to law.
Sources for More Information
- Investopedia: This platform provides reliable and comprehensive definitions and explanations for various financial terms including Bills of Exchange and Promissory Note.
- Accounting Tools: This website offers in-depth articles and resources about accounting and finance concepts, and can provide more insights on the difference between Bills of exchange and Promissory note.
- Corporate Finance Institute: This source offers online courses as well as free resources on financial topics, including the differences between types of notes and bills.
- The Balance Small Business: This site provides articles and advice on small business operations, finance, and tax issues which will include explanations of financial instruments such as Bills of Exchange and Promissory Note.
