Discounting Of Bills Of Exchange

Bills of exchange are written orders that bind an individual or organisation to pay a specific amount of money to another immediately or at a specific date. It’s essentially a short-term negotiable financial instrument that can be written up by individuals or banks. 

The Drawer (maker) must sign the bill and the sum has to be certain. 

It remains just a draft until it is accepted. Writing “Accepted” on it makes it a bill of exchange. 

Example: 

If Andy sells some goods to Tristan for a certain amount of money, but Tristan cannot afford to pay Andy immediately and can only pay at the end of the month, then Tristan can draw this instrument up in Andy’s favour. This will state that Tristan commits to payment of Andy at a particular date. He will also sign the bill. 

If Andy cannot afford to wait that long, then he could approach a bank and instructing it to pay him now and to collect the amount on his behalf from Tristan. 

The amount that is paid to Andy by the bank is discounted, because it will have deducted commissions. 

What does discounting of bills of exchange mean? 

This means that it is sold to a bank, for early payment. This sale is at less than face value because the bank will have deducted fees and interest. When payment becomes due, the bank collects full value. 

Banking institutions offer a range of services to clients. Aside from their core offerings, banks also act as agents by facilitating inter-account payments. Discounting of bills of exchange enables individuals to collect the funds that they need immediately, rather than having to wait for a predetermined date. Not only is this convenient in terms of accessing money faster, but it also helps for business owners to remain liquid and to maintain cash flow.