What is a Draft?
A draft, also known as a bill of exchange, is a written order by one party (the drawer) instructing another party (the drawee) to pay a certain sum of money to a third party (the payee) on a specified date.
Types of Drafts
There are two main types of drafts:
1. Sight Draft:
- Payment is due immediately upon presentation of the draft.
- Commonly used for short-term transactions.
2. Time Draft:
- Payment is due at a future date specified in the draft.
- Often used for longer-term transactions.
How Does Pay by Draft Work?
- Issuing the Draft: The buyer (drawer) issues a draft to the seller (payee) through a bank (drawee).
- Presentation of Draft: The seller presents the draft to the bank for payment.
- Payment by Bank: The bank pays the seller the amount specified in the draft upon due date.
- Debit to Buyer's Account: The bank then debits the buyer's account for the amount paid.
Advantages of Pay by Draft
- Security for the Seller: The seller is assured of payment as long as the buyer has sufficient funds in their account.
- Deferred Payment: The buyer can have a grace period before payment is due.
- Documentation: The draft serves as a written record of the transaction.
Disadvantages of Pay by Draft
- Complexity: The process of issuing and presenting a draft can be complex and time-consuming.
- Risk for the Seller: If the buyer's account has insufficient funds, the seller may not receive payment.
- Limited Use: Drafts are not as widely used as other payment methods, such as bank transfers or credit cards.
When to Use Pay by Draft
Pay by draft is most suitable for:
- Domestic transactions: Drafts are generally used within a country.
- Transactions with established businesses: Drafts are more common among companies with established relationships.
- Transactions requiring deferred payment: Drafts allow for a grace period before payment is due.
Conclusion
Pay by draft is a traditional payment method that offers both advantages and disadvantages. While it provides security for the seller and flexibility for the buyer, it can also be complex and time-consuming. Whether it's the right choice for your business depends on your specific needs and circumstances.