A bill of exchange can have different types of draft payment instruments. The most common ones are sight draft and time draft. It becomes payable at sight to the payee.
A sight draft is a preferred payment method by the exporters as it protects them from the default risk. An exporter can keep the title of goods shipped to the importer until receiving the payment with a sight draft.
It can offer different advantages to the exporter as well as to the importer. It is one of the most commonly used payment instruments in international trade. It can be used with ocean or air cargo transportation.
What is a Sight Draft?
A sight draft is a type of bill of exchange that becomes payable at sight or on demand. The exporter keeps the title of goods until receiving the payment from the importer. Thus, it reduces the default risk of payment for the exporter.
An importer can also make adjustments in this instrument before finalizing the trade deal. Hence, it offers benefits to both parties in a trade deal. However, upon agreement, the importer cannot further delay the payment with a sight draft.
How Does a Sight Draft Work?
When two parties in an international trade agree on terms and conditions, they can agree on different payment methods. A sight draft is a type of bill of exchange that becomes due and payable on presentation.
Once both parties agree on the terms and conditions of a trade deal, they can decide for a bill of exchange to be a time draft. The exporter would ship the prepared goods after receiving the sight draft and other important documents duly signed and verified from the importer.
The exporter would need to present all the shipping documents along with the sight draft to its bank for payment. By definition, the exporter should receive payment immediately upon presenting it. However, the bank would verify the authenticity of the sight draft, LC, bill of lading, and other important documents.
The bank would release the payment upon confirmation from the issuing bank of the importer. The exporter remains safe as it keeps the title of goods until payment is cleared. The importer would also receive the shipment and can ask the issuing bank to release the payment upon confirmation of the shipment. Once the payment is cleared, the importer would receive the title of goods.
Example
Suppose an importer company Green Star Co. from India wants to import some electric components from Germany. It enters into an agreement with a German Firm Blue Tech Co. Both parties agree to use a sight draft as a payment method.
Once Blue tech confirms the trade deal, it would start manufacturing. It would then ask for a sight draft from Green Star Co. Before shipment of goods. It will enable Blue Tech to keep the title of goods until Green Star in India clears the payment.
Green Star would receive the shipment and sight draft through its issuing bank. IT would then confirm to the issuing bank to release the payment. Blue Tech will receive the payment and confirm with its bank. Green Star can only receive the title of goods once the payment is cleared.
The process of clearing it might take several working days before it is actually cleared.
Special Considerations with a Sight Draft
It is payable on demand or presentation. However, in practice, it takes several working days to clear payment. It can cause delays in releasing the shipment of goods at the destination as well.
The exporter may face certain risks with it despite its utility in several ways. For instance, if the importer does not receive the shipment for some geographical reasons, the exporter would not get the payment. The shipment would also return to the origin.
Advantages of Using a Sight Draft
It offers several advantages to both parties in international trade.
- It protects the exporter against the default risk of the importer.
- It becomes payable with presentation or demand, hence saves time for the exporter.
- The importer can obtain discounts with quick payment through sight draft.
- It facilitates international trade between trusted and new trade partners.
Disadvantages of Using a Sight Draft
A sight draft comes with some disadvantages as well.
- The exporter may face certain risks of non-payment under special circumstances, for example, if the importer refuses to receive the goods.
- Itdoes not fully eliminate the risk of default of the importer.
- The exporter may have to offer some discounts against quick payment from the importer.
Conclusion
A sight draft is a type of bill of exchange that becomes payable on demand or presentation. The exporter keeps the title of shipment until the payment is cleared. It’s a relatively faster payment method than a time draft.