Time draft and sight draft are both payment instruments used in international trade. Both types of instruments offer certain benefits to both parties in a trade deal. A time draft is a confirmed payment for the exporter but comes with a delay. A sight draft is a quicker payment method but becomes payable upon presentation or demand.
The working mechanism of both instruments is based on similar principles. However, these are some key differences in both instruments such as acceptance, time, discounting, etc.
What is a Time Draft?
A time draft becomes payable after a certain period as specified on the instrument. It comes with a specific payment date. However, if the importer agrees, it can also be paid earlier than its maturity date.
A time draft is a confirmed payment instrument. The issuing bank becomes a guarantor to the exporter for the payment of the time draft. Thus, the instrument becomes marketable security as it acts as a short-term credit facility. Hence, the exporter can sell the time draft at a discount to the other party for early payment.
How Does a Time Draft Work?
Once both parties agree on the terms and conditions of the trade deal, they can choose a time draft as a payment method. The importer would need credit approval from the issuing bank for a time draft as it is a confirmed payment instrument.
Both parties can agree on the terms of a time draft. For instance, a time draft can be issued with a 60-days maturity date after receiving the shipment of goods. It can also be arranged with different terms of maturity date such as a specified Calander date.
The exporter can hold the time draft till maturity and receive the full payment. It can also sell the marketable security (time draft) in the market at a discount to receive the payment quickly. The buyer can hold it or further discount to other parties. The final holder of the instrument receives the full payment at maturity.
What is a Sight Draft?
A sight draft is a type of payment draft that becomes payable at sight. It means, the issuer cannot delay the payment with a sight draft. The exporter keeps the title of goods until the payment is cleared. Thus, an importer would need to confirm the payment immediately to receive the shipment of goods.
As the sight draft becomes immediately payable at presentation, it cannot be discounted. The payment confirmation also comes from the buyer with a sight draft. The importer cannot hold the payment once it confirms the accuracy of shipment documents.
How Does a Sight Draft Work?
A sight draft works similarly to a time draft with some exceptions. Both parties can use a sight draft as a payment method in trade deals. Once the exporter ships the goods, it can then ask for a sight draft. The importer can confirm the accuracy of the shipment documents and the letter of credit along with other documents before releasing the payment.
Once the importer confirms, the exporter can immediately present the sight draft. A sight draft is payable upon presentation immediately. The exporter holds the title of shipment until the payment is cleared. However, it can be a risk for the exporter as well. For instance, the importer may refuse to receive the shipment, or some macroeconomic factors can cause a delay in the shipment. Thus, the exporter would not receive the payment as there will be no confirmation of goods.
Time Draft vs Sight Draft – Key Differences
Let us consider some key differences in both types of payment instruments.
Payment Time
A time draft would be paid with a delayed maturity date as the name suggests. It can be arranged in different ways such as with a maturity date after 60 days of receiving the shipment of goods.
A sight draft on the other hand is payable upon presentation. Once the importer confirms the shipment documents, it cannot hold the payment through a sight draft.
Discounting
A time draft is backed by the bank guarantee for payment, it becomes a certain payment instrument. Thus, it can be discounted for a quicker payment than a sight draft.
A sight draft cannot be discounted as it does not offer any incentive for investors.
Title of Goods
A time draft formally arranges a delayed payment date, the exporter cannot hold the title of goods until the payment. The importer receives and transfers the title of goods before the payment is released.
A sight draft offers an advantage to the exporter for keeping the title of goods until the payment is cleared.
Risk of Default
For some reason, both instruments cannot fully eliminate the risk of default of the importer. However, with a time draft, the risk of default transfers to the issuing bank. Thus, the exporter faces less risk with a time draft than a sight draft.
