What Is a Time Draft?
A time draft is a form of payment that is guaranteed by an issuing bank but is not payable in full until a specified amount of time after it is received and accepted. Many international trade transactions use drafts as a way to indicate the terms of payment for shipped goods. A time draft allows the importer (or buyer) time to pay for the goods received from the exporter (or seller). Time drafts are a type of short-term credit used for financing transactions of goods in international trade.
- A time draft is a type of payment document whereby a buyer accepts shipped goods and agrees to pay the seller at a specified future date.
- It is a type of short-term credit used to finance international transactions.
- A time draft is also a guaranteed payment to the seller by an issuing bank.
- Time drafts give the importer time to pay for goods received from the exporter.
How Time Drafts Work
The purpose of time drafts is to facilitate international trade. When an exporter receives an order from an unknown importer (or with which it has little credit history) in another country, the importer can apply for a banker's acceptance with their bank, which substitutes the bank's credit for the importer's credit. The banker's acceptance is a negotiable instrument or document that allows the bank to guarantee payment to the exporter for the shipped goods.
The payment is due at a particular date in the future after the goods are shipped. As a result, the document is called a time draft, which functions similarly to a post-dated check. However, the bank—instead of the importer—guarantees the payment.
The post-dated payment allows the importer time to receive the ordered goods and confirm satisfaction. After the issuance of the banker's acceptance, the exporter now possesses a promise of payment from the financial institution. It can hold this asset until maturity and be paid in full, or sell it before maturity at a discount to obtain earlier access to the funds. The time between acceptance and maturity is called "tenor" or "usance." As a result, time drafts may be referred to as "usance drafts."
Time Draft vs. Sight Draft
A sight draft is another type of draft used in international trade. A sight draft allows the seller (or exporter) to hold the title—or ownership—of the goods until the importer receives them and makes a payment. Once the importer accepts the documents and everything appears in order, the sight draft requires immediate payment from the buyer to the seller.
As a result, the key difference between a time draft and a sight draft is that sight drafts require an immediate payment while time drafts allow the importer to pay at a later date.
Example of a Time Draft
Suppose a manufacturer of high-tech hardware based in Texas needs electrical components from a supplier in Taiwan. The Taiwanese company has never done business with the U.S. manufacturer. To facilitate the transaction, the importer in Texas presents a time draft (with a two-month post-date for payment) to a large global bank with a branch office in Taipei, Taiwan, which then accepts it, thus officially creating a banker's acceptance.
The exporter in Taiwan ships the order of electrical components. The buyer accepts the documents and agrees to pay the exporter in 60 days as stipulated in the time draft. Once the buyer agrees to the terms of the draft, the buyer takes the shipping documents, which are used to facilitate the release of the goods located at the dock. The exporter decides to hold the banker's acceptance until maturity instead of selling it at a discount prior to maturity.