Documentary Draft Business Definition
A documentary draft is a type of financial instrument that allows a seller to receive payment for goods or services even though the buyer has not yet received the goods or services. It is essentially a promise to pay, supported by documents that prove the shipment of goods or the delivery of services.
How It Works
Here's a breakdown of the process:
- Exporter (Seller) ships the goods to the importer (Buyer).
- Exporter presents the shipping documents (Bill of Lading, Insurance Certificate, etc.) to the bank.
- Bank verifies the documents and releases the payment to the exporter.
- Importer receives the goods and makes payment to the bank.
Key Components
- Bill of Lading (B/L): A document issued by the carrier confirming the shipment of goods and acting as a receipt.
- Insurance Certificate: This documents the insurance coverage for the shipment.
- Draft: A written order from the exporter to the importer demanding payment.
- Documentary Credit: A commitment from the importer's bank to pay the exporter upon presentation of specific documents.
Benefits of Documentary Drafts
- Secure Payment for Exporters: The exporter receives payment even before the importer receives the goods, reducing risk.
- Flexibility for Importers: The importer can inspect the goods before paying, reducing the risk of receiving faulty or incorrect goods.
- Documentation as Proof: The documentary nature provides a record of the transaction and protects both parties.
Risks Involved
- Fraud: There's a risk of fraudulent documents being presented, potentially leading to payment without actual goods.
- Document Discrepancies: If documents do not match the terms of the agreement, the importer may refuse payment, delaying the exporter's payment.
Conclusion
Documentary drafts are a widely used financial instrument in international trade, facilitating secure and reliable transactions. While they offer numerous benefits, it's important to understand the associated risks and implement measures to mitigate them.