Definition
In accounting, the term “draft” has multiple meanings, each relevant to distinct financial processes:
1. Bank Draft
A bank draft is a payment instrument issued by a bank on behalf of a customer, guaranteeing that a certain sum of money will be paid to a specified party. Once issued, this draft cannot bounce due to insufficient funds as the payment amount is immediately debited from the customer’s account.
2. Order to Pay
A draft can be any written order to pay a specified sum of money, essentially functioning similarly to a bill of exchange. This concept is used in various financial transactions to ensure a committed payment at a specified time.
3. Preliminary Document
In documentation terms, a draft refers to a preliminary version of a document that is not yet finalized. This initial version is often used for review, feedback, and revisions before producing the finalized edition.
Examples
Bank Draft Example
A company needs to pay a vendor $10,000. To ensure the payment is securely handled, the company requests a bank draft from their bank. The bank issues a draft payable to the vendor, and the vendor can deposit it in their bank, ensuring guaranteed payment.
Order to Pay Example
In international trade, a seller may issue a draft to a buyer stipulating that the buyer must pay $50,000 within 90 days. This draft can be transferred between parties and serves as a guarantee of payment.
Preliminary Document Example
An accountant prepares a draft of the annual financial report. This document is circulated among the board members for review and feedback before the final version is completed and published.
Frequently Asked Questions
What is the difference between a bank draft and a personal check?
A bank draft is issued by a bank and guaranteed by its funds, while a personal check is drawn directly from an individual’s account and may not have guaranteed funds.
Can a bank draft be canceled?
Typically, once issued, a bank draft cannot be canceled as the funds have already been secured by the bank for the payee.
How does a draft differ from a bill of exchange?
A draft serves as a generic term for an order to pay a specified amount, while a bill of exchange is a specific type of draft used particularly in international trade.
What are the common uses of a preliminary draft document?
Preliminary drafts are commonly used for review, feedback, and revisions before finalizing policy documents, financial reports, contracts, and other important documents.
How secure is a bank draft compared to other payment methods?
A bank draft is very secure since the funds are guaranteed by the issuing bank, reducing the risk of non-payment.
Related Terms
Bill of Exchange
A legally binding instrument in international trade that orders a designated party to pay a set sum of money to the holder of the instrument on demand or at a specified future date.
Certified Check
A type of check for which the issuing bank guarantees that sufficient funds exist in the holder’s account and that the signature is genuine.
Promissory Note
A financial instrument that contains a written promise by one party to pay another party a definite sum of money either on demand or at a future date.
Letter of Credit
A document issued by a bank guaranteeing a buyer’s payment to a seller will be received on time and for the correct amount, often used in international transactions.
Online References
- Investopedia: What is a Bank Draft?
- The Balance: Understanding Bills of Exchange
- Wikipedia: Promissory Note
Suggested Books for Further Studies
- “Accounting and Finance for Non-Specialists” by Peter Atrill and Eddie McLaney.
- “International Finance: Theory into Practice” by Piet Sercu.
- “Financial Accounting: The Impact on Decision Makers” by Gary A. Porter and Curtis L. Norton.
- “The Essentials of Finance and Accounting for Nonfinancial Managers” by Edward Fields.
Accounting Basics: “Draft” Fundamentals Quiz
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