A time draft is a type of foreign exchange draft that allows for a delay in payment. Unlike a sight draft, which requires immediate payment upon presentation, a time draft specifies a future date (or a set period after the draft’s acceptance) when payment will be made. It is essentially a short-term credit instrument.
Here’s how a time draft works:
- Issuer and Payee: One party (the drawer or issuer) creates the draft, instructing another party (the drawee or payee) to pay a certain amount to a third party (the payee or beneficiary) or to the drawer itself.
- Specified Date: The draft stipulates a future date when payment will be due. This can be a fixed date or a set number of days after the draft is accepted by the drawee (e.g., “60 days after acceptance”).
- Acceptance: For the draft to become binding, the drawee (or the party expected to make the payment) must “accept” the draft. This is typically done by marking it with the word “accepted” and adding a signature.
- Trade Transactions: Time drafts are commonly used in international trade, allowing the buyer (importer) some time to sell the received goods and generate the funds needed to pay the seller (exporter).
Example of a Time Draft
Let’s use a simplified real-world example involving a furniture manufacturer and a retail store:
Furniture Manufacturer (FM): Based in Italy, specializes in high-end wooden furniture. Retail Store (RS): A luxury furniture store located in the United States.
- Negotiation: RS negotiates with FM to purchase 100 luxury wooden tables. Given the handcrafted nature of the tables and the reputation of FM, the total cost is substantial. RS, recognizing the sales potential during the upcoming holiday season, wants the tables but requests a delay in payment due to current cash flow constraints.
- Time Draft Agreement: FM agrees to the sale but, understanding the payment concerns, proposes a 60-day time draft. This would mean that RS has 60 days from accepting the draft to make the payment. RS agrees to this arrangement.
- Shipping & Documentation: FM ships the tables to RS and draws up a time draft, specifying the total amount due in 60 days. FM sends the time draft and shipping documents to its bank, which then forwards them to RS’s bank in the U.S.
- Draft Acceptance: RS receives notification from its bank about the arrival of the documents. RS reviews and then “accepts” the time draft by marking it as “accepted” and signing it. By doing this, RS legally commits to paying the amount specified in 60 days.
- Release of Goods: Once the time draft is accepted, RS’s bank releases the shipping documents, allowing RS to take possession of the tables and display them in the store.
- Payment: Over the next two months, RS successfully sells a large portion of the tables, generating significant revenue. On the 60th day after accepting the draft, RS’s bank automatically deducts the agreed amount from RS’s account and remits payment to FM’s bank in Italy. The transaction is complete, and FM has been paid in full.
In this example, the time draft facilitated international trade by allowing RS some flexibility in payment timing, while FM still had a binding commitment that they would receive their payment within the specified period.