Instruments of Credit

Learning Objectives

Why it is vital for a business to sale on credit? To define on what basis instruments are classified? Importance of these instruments. How to apply these instruments? To understand the difference between Inland and foreign bills

Classifications of Instruments of Credit

Pay Roll Credit

Open Book Accounts

Promissory Note

Cheques

Documentary Credit
Bills of Exchange

Instruments of Credit
Pay roll Credit
Pay roll credit is also called Oral Agreement. Because in this credit a Borrower gets something from the Lender without any written contract. In case a Borrower refuses to pay then Lender cannot claim any obligation.

Instruments of Credit
Open Book Account This instrument is
consist of entries. In this credit a debtor has entries as Account Payable and creditor has entries as Account Receivable. It is the speedy way of carrying on the business transaction.

Instruments of Credit
Documentary Credit instruments
This instrument is consist of written agreement in which Creditor gives the specific time period to the Debtor to make payments in the future. It can be a Contract or to be a Promise.

Negotiable Instrument
A negotiable instrument is a specialized type of contract for the payment of money that is unconditional and capable of transfer by negotiation.

Characteristics of Negotiable Instrument

Transferable by delivery Entitled to receive money Filling a suit Transferee is not affected by defective title

Negotiable Instruments
Promissory Note Bill Of Exchange

Cheque

Promissory Note

According to Section 4 of the Negotiable Instruments Act defines promissory-note as under: Promissory note is an instrument in writing( not being a Bank Note or a Currency Note) containing an unconditional undertaking signed by the maker, to pay on demand or at a fixed or determinable future time, a certain sum of money only, to, or to the order of a certain person, or to the bearer of the instrument.

Essentials of Promissory Note

Unconditional Written Order Signed by THE Maker Pay certain sum of Money Payable to or to the order of a certain person Made by two or more persons Amount promised

Advantages of Promissory Note

Witnesses of both the parties Easy way to ensure Future Payment No chance of Fraud by the Borrower Simple and Easy

Promissory Note
Rs. 50,000
Stamp

Lahore August 1, 2005

Sixty days after for value received, I promise to pay, Mr. A or order the sum of Rs. Fifty thousand only.

Mr. A 10 G. Gulberg, Lahore

Mr. B Signature

According to Section 4 of the Negotiable Instruments Act defines Bill of Exchange as under:

An instrument in writing containing an unconditional order, signed by the maker, directing a certain person to pay a certain sum of money only to or to the order of a certain person or to the bearer of the instrument, on the demand or at a fixed future time.

Parties of Bills of Exchange

Drawer:
The party who draws the bill is called Drawer or the Maker.

Drawee:
The party to whom the bill is addressed or on whom the bill is drawn.

Payee:
The party to whom the bill is made payable. It may be drawer or any other party.

Features of Bills of Exchange

Order:
The bill of exchange is an order for payment not a request to debtor.

In writing:
The order of payment for debtor is always in

writing.

Unconditional:
order for payment. The bill of exchange is an unconditional

Certain Amount Specified Person (Drawee) Acceptance

Difference b/w Inland & Foreign Bill

Points
Parties

Inland Bill
Both Parties (drawer & Drawee) belong to one or same country

Foreign Bill
The drawer and Drawee do not belong to same country

Copies

Only one copy of inland bill is prepared

Three copies of foreign bill are prepared.

Revenue stamp

Revenue stamps are pasted once on inland bill

Revenue stamps are pasted twice on foreign bill.

Difference b/w Inland & Foreign Bill

Period
The period of inland bill is considered from its issuance. The period of foreign bill is considered from its acceptance

Currency

The amount is written in local currency on inland bill.

The amount on foreign bill is written in the currency of drawees country

Advantages of Bills of Exchange

Written Verification of debt Negotiable Instrument Discounting facility Easy transfer of money Self Liquidating Credit Facilitates foreign trade

Bills of Exchange
Rs. 40,000 2005 Lahore August 1,

Two months after date pay to Mr. A or his order the sum of Rs. Fourty Thousand only, for value received. To Mr. B 10 G. Gulberg, Lahore

Mr. C Signature

According to Section 4 of the Negotiable Instruments Act defines promissory-note as under:

A cheque may be defined as a written order of a depositor upon a bank to pay to or to the order of a designated party or to bearer, a specified sum of money on demand.

Main Types of Cheque

Cheque
Open Cheque
Bearer Cheque
Order Cheque

Crossed Cheque
General Crossing Special Crossing

Main Types of Cheque

Open Cheque:
Open cheque are those cheque which are paid across the counter of the bank. Open cheque may be bearer or order cheque.

Bearer Cheque Order Cheque

Crossed Cheque:
If a cheque is crossed by drawing two parallel lines across the face of the cheque, with or without the words & Co or A/c payee only, it is called a crossed cheque.

General Cheque Special Cheque

Importance of Cheque

Convenient and safe method Transfer of funds from one place to another Safety to money deposited into bank Purpose of receipt also Saving of use of currency notes

Promissory Note & Bills of Exchange Contrast

Promise to Pay Two parties involved Unconditional Promise Not payable to the maker Needs no acceptance No notice in case of dishonor Not drawn in Sets Liability of Maker is Primary
Order to Pay Usually three parties Unconditional Order Payable to the drawer Acceptance is must

Notice in case of dishonor Drawn in Sets Liability of the Drawer is Secondary

Cheque & Bills of Exchange Contrast

Drawn on a bank Payable on demand Acceptance is required

not

Immediately payable It can be crossed No need of dishonor notice Payable on demand to bearer Stoppable by the drawer No stamp requirement

Drawn on some person or firm Payable till the expiry of a fixed period Acceptance is necessary Three days of grace are allowed for payment No crossing of bill Dishonor notice is necessary Unable to stop by the drawer Noted and protested to establish dishonor Properly stamped

Main Modes of Inland Remittances by Commercial Banks Bank Draft Pay order Telegraphic Transfer Mail Transfer Inland Travelers Cheque Credit Cards