Bills of Exchange

The full picture

Imagine you sell ₹50,000 worth of fabric on credit to a retailer. You need cash for your next purchase, but the retailer will only pay in 90 days. What do you do? A bill of exchange solves this problem. It is a written, unconditional order from you (the drawer) to the buyer (the drawee) to pay a fixed sum — either to you or to whoever you name as the payee — on or before a specified date. In India, bills are governed by the Negotiable Instruments Act, 1881, so they carry real legal weight: the drawee who refuses to pay can be taken to court.

Three parties appear in every bill. The drawer is the creditor — usually the seller — who writes the bill and orders payment. The drawee is the debtor — the buyer — who is ordered to pay. The payee is whoever receives the money; often the drawer and payee are the same person, but not always. A bill becomes binding only after acceptance: the drawee writes 'Accepted', signs, and dates the bill. Until that moment the bill is just an order with no legal force against the drawee. After acceptance it becomes an enforceable obligation. One common confusion: acceptance does not remove the drawer's contingent liability. If the drawee fails to pay at maturity (dishonour), the holder can claim from the drawer too — so the drawer remains on the hook as a backup even after the bill is accepted.

Once a bill is accepted, the holder has four main choices. First, they can keep the bill and collect the full amount at maturity. Second, they can discount the bill at a bank — hand it over before the due date in exchange for cash now, minus a discount charge calculated as: Discount = Face Value × Rate × Time. The bank then collects from the drawee at maturity; the discount is the bank's profit for taking the risk. Third, the holder can endorse the bill to a creditor, signing the back of the bill and passing the payment entitlement to someone else — a neat way to settle your own debt without using cash. Fourth, the parties may agree to renew the bill if the drawee cannot pay on time: the old bill is cancelled, a new one is drawn (often with extra interest), and accounting entries reflect the change.

What happens when a bill is dishonoured? The drawee fails or refuses to pay on the due date. The holder — whether the original drawer or a bank that discounted the bill — immediately has the right to recover the money. If the bill was discounted and the bank receives no payment, the bank debits the drawer's account for the full amount; the drawer then has a claim on the drawee. This is why tracking who holds the bill at each moment is the key skill in this chapter — it tells you exactly which entries appear in whose books.

There is one more important type: the accommodation bill. Here, two friends in business — say Arun and Biju — draw a bill not because there was any actual sale, but purely to raise funds. Arun draws on Biju, Biju accepts, and Arun discounts it at a bank. They split the cash and agree to meet their respective shares before the bill falls due. Since there is no real trade behind it, an accommodation bill is handled differently in the accounts: the party who received more of the proceeds bears the larger share of the discount expense. This contrasts with a trade bill, which always has a genuine credit sale at its origin.

An Indian example

Rahul runs a small cashew processing unit in Kollam. In October, just before the festival season, he supplies ₹1,20,000 worth of packaged cashews to a supermarket chain in Thiruvananthapuram on 60-day credit. The chain accepts a bill Rahul draws on them. But Rahul needs money immediately to buy raw nuts for the next batch. He takes the accepted bill to his branch of South Indian Bank, which discounts it at 9% per annum. The bank calculates the discount: ₹1,20,000 × 9/100 × 60/365 = ₹1,775 (approx), so Rahul receives ₹1,18,225 in his account that same afternoon. Sixty days later, the supermarket pays the bank ₹1,20,000; the bank keeps ₹1,775 as its fee. Rahul got his working capital without taking a conventional loan, the supermarket got its festival stock on credit, and the bank earned a clean short-term return — everyone wins. If the supermarket had refused to pay on day 60, the bank would have charged the full ₹1,20,000 back to Rahul's account, reminding us that the drawer always carries contingent liability.

Common misconceptions to watch for

• WRONG: 'A bill of exchange is the same as an invoice — both are documents issued in credit sales.' RIGHT: An invoice is just a record of the sale with no special legal power. A bill of exchange is a negotiable instrument under the Negotiable Instruments Act, 1881 — it can be discounted at a bank for immediate cash, endorsed to settle your own debts, or transferred to anyone; an invoice cannot do any of these things.
• WRONG: 'Once the drawee accepts the bill, the drawer is off the hook — all liability shifts to the drawee.' RIGHT: Acceptance makes the drawee the primary debtor, but the drawer retains contingent (backup) liability. If the drawee dishonours the bill at maturity, the holder can go back to the drawer for recovery. This is why dishonour entries always re-debit the drawer or the endorser who passed the bill.
• WRONG: 'Discounting reduces the amount the drawee owes — the debt is partially cancelled.' RIGHT: Discounting is a short-term loan from the bank to the bill-holder, not a debt reduction. The drawee still owes the full face value at maturity. The discount amount is simply the bank's interest charge for advancing cash early; the holder receives less cash now, but the drawee pays the full amount to the bank on the due date.