What is Trade Acceptance and How Does It Work?

A trade acceptance is a bill of exchange with a promise to pay by the buyer. It is widely used in international trade. An acceptance provides further assurance to the seller of payment. Unlike a common type of bill of exchange, a trade acceptance becomes a legal obligation. It comes with the amount and payment date with other formalities in the written form.

It is similar to a banker’s acceptance. The key difference is the guarantor with a banker’s acceptance is the issuing bank of the buyer. Whereas in a trade acceptance the bank does not provide any guarantee on buyer’s default.

What is a Trade Acceptance?

A trade acceptance involves an acceptance of a bill of exchange by the buyer to guarantee payment on a specified date. The bill of exchange or a time draft in itself comes as a negotiable instrument. An acceptance provides additional assurance to the seller of payment on a specified date.

It becomes a legal obligation for the buyer. The buyer may secure a separate financing facility to confirm the payment. However, the bank does not provide funds for clearing the acceptance, unlike a banker’s acceptance.

How Does a Trade Acceptance Work?

Both parties in a trade deal can decide to add the acceptance to an already decided time draft or a bill of exchange. Once agreed by both parties, the seller would ship the trade acceptance form along with other documents to the buyer.

The buyer would then verify the accuracy of the trade contract and shipping documents to confirm the payment terms. The buyer would proceed with the time draft and authenticate the acceptance form. Once agreed by the buyer, and acceptance becomes a legal obligation.

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The buyer can adjust for any changes in the final payment amount at this stage. For instance, if the buyer negotiates a discount against acceptance, the difference can be adjusted at this point. However, both parties must agree to the changes made in the final payment draft.

It does not come from a bank. The issuing bank of a time draft can add a banker’s acceptance. However, in the case of a trade acceptance, the buyer is the sole guarantor of the payment.

An acceptance specifies the date and amount of the payment to be made to the seller. The buyer would then forward the acceptance form and other shipping documents to the seller. Once the seller ships the goods, they can move to the bank for payment clearance.

The seller holds the option of discounting the time draft to another party. A trad acceptance also adds further security to the time draft. Hence, it makes it easier for the seller to discount the time draft to other parties and receive the payment in advance.

Special Considerations with a Trade Acceptance

A trade acceptance is linked with a particular transaction. It means the acceptance cannot be used for settling past debts even from the same parties.

Discounting of a trade acceptance would largely depend on the issuing company’s financial strength. Although the accompanying draft would come with a bank’s backing.

It has some different features from other financial instruments such as commercial papers. Commercial papers and notes can be used to settle previous debts, however, a trade acceptance cannot be used for any other payment than the transaction itself.

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The issuing bank of a time draft would eventually clear the payment to the seller. The time draft comes with a bank’s assurance. However, the trade acceptance means a default would be on the buyer and not the bank. Either way, the seller gets the assurance of payment through a legal contract.

Advantages of using a Trade Acceptance

A trade acceptance provides several advantages to both parties in a trade deal.

  • It complements the trade documents, contracts, and payment terms agreed by both parties.
  • As a legal obligation, it confirms the payment to the seller.
  • It can be used as a credit facility with discounting to other parties.
  • Faster payment through discounting helps the seller with liquidity issues.
  • It reduces the payment collection costs and facilitates the payments in international trade.

Disadvantages of Using a Trade Acceptance

A trade acceptance can come with some limitations to both parties as well.

  • A buyer would need to arrange sufficient capital to issue an acceptance.
  • A bank does not endorse a trade acceptance, unlike a banker’s acceptance.
  • There is always a risk of fraud or misconduct with such security instruments if the trade deal takes place between two unfamiliar parties.

Conclusion

A trade acceptance is a legally binding document for a buyer to make payment on a certain date. It provides further assurance to the seller and reduces the risk of default of the buyer.

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