Meaning of Time Draft
Time Draft is a document acknowledging a promise to make a payment after a specific period. It is usually used in international trade and provides the buyer of goods some time to make the payment after making the purchase. Hence it is a short-term credit arrangement for the buyer of goods.
In international trade, an exporter of goods might not necessarily know the importer or the buyer of the goods adequately. It would like to involve a Bank for securing its payment. In other words, the bank will “Accept” the time draft on behalf of the buyer. This is called “Banker’s acceptance.” This is done in return for a fee or a charge. The exporter will send the goods on the goodwill and guarantee of the bank involved in between. It will receive the payment according to the time stated in the draft. It becomes the legal obligation of the bank to release the payment to the exporter on the due date.
If the bank has old terms with the importer and knows him well, it can wait and ask the importer to pay at the maturity date. This would facilitate the buyer to first check the goods and confirm if everything is in order and then make the payment. On the other hand, the bank may first take the entire amount from the importer before issuing the Banker’s acceptance to secure its position.
Process Used in Time Draft
After shipping the goods, the exporter sends the shipping documents along with the Time Draft or Acceptance Form to the bank of the importer. The bank gets it “Accepted” from the importer or “Accepts” it on behalf of the importer after either taking the payment or based on his reputation and goodwill. The bank then sends this acceptance to the exporter.
The exporter can hold the document until maturity and realize his payment on the due date. It can also sell the document at a discount in the secondary markets or to a bank itself i.e.; it will accept a lesser payment than the face value to use the sale proceeds immediately. Such documents are traded in the market only if the issuer is credit-worthy and reliable. The discounted amount will be lower than the present value of the acceptance, in mathematical terms. The third-party buying the acceptance, or the bank will wait until maturity to realize the full value of the document. In this process, it will make a gain, which is the motive of the third parties to bear the default risk.
Meanwhile, the importer gets the documents from the bank and can take possession of the goods upon their arrival at the port.
ABC Ventures Pvt. Ltd. of the US wants to buy a consignment of mobile phones from a supplier in China. The importer is apprehensive of making the payment to the supplier. He12 intends to make the payment only after receiving the goods. The supplying company too is unwilling to take the risk and ship the products before payment.
The importer approaches his bank with which it has business terms for long and enjoys goodwill. On the involvement of the bank, the supplying company sends the consignment along with a Time Draft or Acceptance form and the shipping documents to the bank, stating clearly the maturity date.
The bank gets the acceptance of the document from the importer. The importer becomes legally bound to make the payment at the said date. The bank sends back the documents to the exporter, who, on the maturity date, can realize his payment. The exporter can wait for the realization of the draft until its maturity date. Or it can sell it in the secondary market at a discounted value.
ABC Ventures Pvt.Ltd. gets the shipping documents from the bank. It takes the delivery of the consignment upon arrival at the port. It gets a few days to check the goods. On satisfaction concerning the quality and quantity of the consignment, it makes the payment of the draft at the said date with its bank.
Time drafts enable unknown buyers and sellers to conduct trade across different countries. They provide a guarantee of payment to the exporter when a bank gets involved. Also, they provide short- term credit to the importer of the goods.