A negotiable instrument lets you transfer an obligation to pay. It’s a physical piece of paper that guarantees its holder a specific amount of money on a certain date. But the difference between this and a loan agreement is that the document can be negotiated for a discount, early payment or added interest.
Types Negotiable Instrument
The main negotiable instruments are:
- Bills of exchange;
- Promissory notes, which we’ve covered in a previous article; and
- Cheques.
Although, there are many others that won’t be covered in this article, including treasury notes, bonds and letters of credit.
Bills of Exchange
The most commonly used negotiable instrument is a Bill of Exchange. There are two situations where you might use it: to quickly raise money and in trade transactions.
Commercial Bill
Commercial bills (also called accommodation bills) make up a large part of the short-term money market in Australia since they can easily raise short-term finance; you just need to ‘draw’ up a bill and sign it to make it valid. They usually provide financial support (accommodation) or credit for one or more parties.
Find out other ways to raise your finance in our Guide for Businesses.
Banks can accept a commercial bill. For a fee, you can trade a bill with a bank in exchange for a loan and then, once the bill matures, you repay the bank in full plus any interest or discounts. But the bank can pass a bill to an investor – who can sell it to someone else – so that when you repay the bank they pay back whoever is holding the bill at the same time.
Trade Bill
International trade transactions commonly use trade bills as a form of documentary credit. They allow debt obligations with an extended payment period to be created between trade partners.
Companies mainly use trade bills for exchanging goods. You can sell goods to a buyer on credit (they pay you back at a specific time) and then instruct them to pay someone else by drawing up a bill Once the buyer accepts the bill (by signing it), the bill is sent over to the third party, who can negotiate the bill with the buyer. For example, they might negotiate payment from the buyer sooner at a discounted price.
Promissory Notes and Cheques
The difference between bill of exchange, promissory note and cheque lies in the time of payment and who the payment goes to.
A promissory note is written out to a specific person, so the payment won’t go to a third party, whereas in a bill of exchange, document transfers are recorded on a register to keep track of who the holder is.
On the other hand, a cheque is payable on-demand, which means that it can be cashed in at any time rather than at a specified time like a bill of exchange or promissory note.
