Every business involves exchange of money. This infact is the core of any business as businesses operate to earn money. As businesses grow in size, large value cash transactions become both cumbersome as well as restricted by tax laws in several jurisdictions. This necessitates the needs for different modes of payment. There is a plethora of online and offline modes available today. Offline modes are in the form of exchange of negotiable instruments–a document that provides for payment of a specific sum of money at a specific time to the payee mentioned in the document.
This article looks at meaning of and differences between two types of negotiable instruments – cheque and demand draft.
Definitions and explanations
A cheque is a negotiable instrument that instructs the bank to pay the amount specified therein, to either the bearer of the instrument or the payee mentioned in the instrument, by debiting the bank account of the person issuing the cheque.
The parties to the cheque are:
Person writing the cheque – the drawer
Person to receive the cheque amount – the payee
Bank on which the cheque is drawn – the drawee
Blank cheques are given to bank customers (drawer) in the form of a cheque booklet. These lie in the custody of the drawer who can fill them with the required date and amount, name of the payee and then sign and issue them to their creditors (payee).
Payees proceed to present the cheque for clearance at their bank. The bank confirms that the drawers bank account has sufficient account balance and makes payment to the payee once the internal bank processing formalities are complete and the bank account of the drawer is duly debited. In case the drawer’s bank account does not have sufficient balance, the cheque is not cleared and the payee does not receive the money – termed as cheque bounced or cheque dishonored.
Cheques may take several days to complete especially if the bank of the drawer and payee are different.
Cheques are of 2 types – bearer cheque and account payee cheque.
The amount of a bearer cheque can be credited to the bank account/ paid in cash to any person who holds the cheque and presents the same.
An account payee cheque can only be credited to the bank account of the person whose name is written in the cheque as the payee.
A demand draft is a negotiable instrument issued by the bank that instructs another bank or its branch to pay the amount specified therein to the account of the payee mentioned in the instrument, on demand.
When an entity (payer) wishes to make a payment to another entity (payee) by way of a demand draft, he approaches a bank for issue of the same. The payer makes a request to the bank to issue a demand draft of a specified amount in favor of a specified payee. The bank will issue a demand draft only on once the payer makes payment of the amount – this can be paid by debit to the bank account of the payer or even by cash. Thus, it is not necessary that the payer have an account in the bank to make a request for issuing a demand draft.
The key feature of a demand draft is that it is payable to the payee on demand i.e., immediately when it is presented for payment by the payee to the bank. As the demand draft amount has already been collected by the drawer bank, the payment is immediately released on presenting of the demand draft by the payee.
Difference between cheque and demand draft:
The difference between cheque and demand draft has been detailed below:
- A cheque is a payment mode that involves an instruction to the bank to pay the specified amount to the bearer/specified payee by debiting the bank account of the drawer.
- A demand draft is a payment mode that gives an order to bank to pay on demand the specified amount to the payee specified in the demand draft.
2. Prepared and issued by
- A cheque is prepared by the payer i.e.: a bank customer.
- A demand draft is prepared by the issuing bank.
3. Payable to bearer
- A cheque can be made payable to a bearer.
- A demand draft cannot be made payable to a bearer and can only be payable to a specified payee.
4. Intervention by bank
- Cheques can be issued directly by persons who have a bank account to the payee, without requiring assistance from the bank.
- Demand drafts have to be prepared by the bank itself and thus cannot be issued by a payer to his payee without intervention from the bank.
5. Timing of payment by the payer
- In the case of a cheque, the bank account of the issued is debited only on presentation and clearance of the cheque by the payee.
- In case of a demand draft, the payment has to be paid by the payer before preparation of demand draft by the banker.
6. Payer bank account
- To issue a cheque, the payer must have a bank account with the bank.
- To issue a demand draft, the payer need not have an account with the bank as the amount can be paid either by cash/cheque.
7. Need for signature
- A cheque requires the signature of the payer to be valid.
- A demand draft is not issued by the payer but by the bank and hence does not require the payer’s signature.
8. Surety of payment for the payee
- A cheque will only be cleared if there are sufficient funds in the bank account of the payer. If not, the cheque will bounce and no payment will be made to the payee. Thus, there is no surety of payment.
- A demand draft has surety of payment as the payment has already been made by the payer, thus it is payable on demand to the payee.
9. Stoppage of payment
- A cheque payment can be stopped by the payer before clearance by instructing the bank.
- A demand draft payment cannot be stopped by the payer once issued to the payee. This can only be done by returning the demand draft to the bank for cancellation and subsequently obtaining a refund from the bank.
10. Time for clearance
- A cheque can take a few days to clear as the bank has to undertake back-end processes to debit the account of the payer.
- A demand draft is payable immediately.
Conclusion cheque vs demand draft:
While cheques have the advantage of ‘stop-payment’ option, to protect the payer in case of any fraud by the payee, it is demand drafts that are considered a safer mode of payment. This is because they have surety of payment for the payee as well as safety from misuse as they can only be paid to the specified payee and not to any bearer. Infact, a lot of establishments do not accept cheques due to this very reason and insist on demand drafts especially for higher value exchanges.