What Are Negotiable Instruments: Meaning, Types & Features
A negotiable instrument is a legal contract between two parties that is used as a payment settlement mechanism. It guarantees a sum of money to the payee or holder of the instrument.
This document clearly mentions the amount of money due to the assignee, which the payer must pay within a set time frame or on demand from the payee. This article will help you understand what are negotiable instruments and why they are so popular in the business ecosystem.
How Do Negotiable Instruments Work?
Negotiable instruments promise a specified amount of payment to the payee. It is transferable in nature, and the final holder of such instruments is eligible to receive payment and use them as per their requirements.
The holder of this instrument has an unconditional claim over the amount mentioned in these instruments. A negotiable instrument is an alternative for cash in economic transactions and allows smooth enforcement of payment obligations.
Some examples of negotiable instruments are bills of exchange, promissory notes, certificates of deposits, etc.
What Are the Types of Negotiable Instruments?
Here are some of the negotiable instruments that are used by individuals and businesses:
- Cheque: A cheque is one of the most popular forms of negotiable instruments. It carries the name of the bearer, account number and other bank details. Money will be debited from the account number mentioned on the cheque. It also contains the name of the payee as well. This ensures that no third person can use that even in case of misplacement. Therefore, cheques have a great amount of security associated with them. There are different kinds of cheques available, like cashier's cheques, traveller's cheques, personal cheques, etc.
- Bills of Exchange: A bill of exchange is a legally enforceable document that guarantees a predetermined sum of a contract to an entity. The payee can receive a sum of money either on demand or at a predetermined date. Various bodies use bills of exchange to settle their transaction of goods or services. These are transferrable, and a payee can also transfer a bill of exchange to some other entity which is obliged to receive payment from the payee. When a financial institution issues a bill of exchange, it is referred to as a bank draft. On the other hand, if a business enterprise issues similar instruments, it is known as a trade draft. Banks are generally a guarantor in case of an issue of bills of exchange. It reduces the risk of default and enforces the credibility of such instruments. Additionally, these instruments are quite common in international trade as well. Exporters address these bills to importers to complete the payment cycl.
- Promissory Notes: It is a negotiable instrument guided by the promise to pay a sum at a specified date. There are two parties – payer and payee, and the payer promises to pay the decided sum of money to the other party. Like other instruments, these notes contain important information like the name of the payee, the amount to be paid, the repayment date and the issuance date. These act as an alternative source of funding. These notes are not that flexible or informal, which implies that there is a loan. On the other hand, these are not as rigid as a loan contract which contains detailed guidelines for repayment as well as consequences associated with default.
- Bearer Bonds: Corporations and governments issue these bonds, which come under the unregistered category. The bondholder receives a regular interest, also called a coupon, and he/she is liable to receive the principal amount on maturity. An entity possessing these bonds is the rightful owner of the same. There is always a possibility of loss, theft or damage to the physical copies of bearer bonds.
- Money Order: These are alternatives to cheques. It is an efficient and simple method of transferring money from one party to another for those who do not have a bank account. In the case of a money order, a payer has to pay the specified amount to the bank as well as the processing or service charge. After the payer deposits the amount, the bank will issue a money order which the payer gives to the payee. The method of transferring money via money order is one of the most secure and risk-free methods. The biggest distinction between cheque and money order is that a money order only records the amount to be transferred and the name of the payer. On the other hand, a cheque contains all personal information about the issuer's bank accounts.
What Are the Features of Negotiable Instruments?
Here are some features of negotiable instruments:
- These instruments must be a written document. They can be printed, handwritten or digitally recorded.
- Users can transfer negotiable instruments from one individual or party to another. This facility of easy transferability gives them a unique identity.
- The name of the payee to whom these instruments are issued must be clearly mentioned in the documents. A person may include any legal entity like a company, corporation, trade union, etc.
- The time of payment is predetermined and must be mentioned in the negotiable instruments. Payees can encash these instruments within the time period mentioned in these instruments.
- Payees of a negotiable instrument have the option to either encash these on a predetermined date or transfer the same to a third party for further use.
What Are the Functions of Negotiable Instruments?
Businesses use different types of negotiable instruments to settle their payment obligations. These instruments are legal tender money and have universal acceptability. It functions as an alternative to coins and currencies as a medium of exchange to buy goods or services.
A negotiable instrument functions on the principle of trust between two parties. They negotiate to arrive at a specified amount which has a settlement date.
What Are the Advantages of Negotiable Instruments?
Negotiable instruments are important and beneficial for businesses due to the following reasons:
- These are quick or instant ways of transferring money.
- It does not involve a lot of paperwork or formalities. Therefore, transferring money from one party to another is a simple and hassle-free process.
- There is no restriction on the number of transfers of promissory notes or bills of exchanges. It can change hands a number of times within the settlement period.
- Debtors can exercise the option of immediate receipts by going to any financial institution and discounting that bill or notes to satisfy their immediate financial requirements.
- A negotiable instrument is also valid for settling claims in international trade as well. Importers and exporters of various countries utilise this option for clearing their financial obligations.
- Unlike non-negotiable instruments, which are rigid and there is no possibility of alteration or modification of terms of the contract, negotiable instruments are more flexible.
A negotiable instrument is legal tender money. You can use them to clear your liabilities. This article about what are negotiable instruments, their types, working as well as advantages will provide useful insight to business owners, which will lead to informed decision making.