What it means
The most common trigger is simply that the payer does not have enough money in the account when the instrument is presented. Other reasons include a closed or frozen account, a signature that does not match, a date that has expired, or a formal instruction from the payer telling the bank to stop the payment.
Finance people distinguish between dishonour by non-payment and dishonour by non-acceptance. Non-payment is the familiar case where the money is refused at presentation; non-acceptance applies to bills of exchange, where the party asked to accept the bill refuses to commit to paying it at all.
Both mean the same thing commercially: the promised cash is not coming on the promised date. Dishonour matters because it turns a settled sale into an open credit problem.
Cash you had already counted in the bank balance vanishes, the receivable is reinstated, and someone has to spend time chasing the customer while the bank charges a returned-item fee on top. The bookkeeping is straightforward once you see it.
You reverse the original receipt, debit the customer's account to put the amount owing back, and post the bank charge as an expense; if you had cleared the invoice, you reopen it so the ageing report shows the true position. There is also a legal layer worth knowing about.
In many jurisdictions the holder must give formal notice of dishonour, and for some instruments a formal protest is required, both of which preserve the right to pursue earlier parties on the instrument. Repeated dishonour is a serious credit warning, and most credit control teams treat a second bounced payment as grounds for moving the customer to prepayment.
In practice
Real-world examples.
Example
A landscaping firm deposits a $7,200 cheque from a housing developer and releases the final plants and materials the next morning. Three days later the bank returns the cheque unpaid because the developer's account was frozen during a dispute. The firm has now handed over stock with no payment and has to reinstate the full receivable.
Example
A subscription software company runs 4,000 monthly direct debits and sees about 40 of them dishonoured each month for insufficient funds. Rather than cancelling those accounts immediately, it retries the collection eight days later, which recovers roughly three quarters of the failed payments.
Example
An exporter draws a bill of exchange on an overseas buyer for $150,000, payable in 90 days. The buyer refuses to accept the bill because the shipping documents do not match the order, which is dishonour by non-acceptance, and the exporter's bank returns the paperwork with a formal notice.
Formula
Calculation
Cost of a dishonoured payment = bank charge + (amount x annual cost of funds x days of delay / 365)
A building supplier banks a customer cheque for $18,500 and treats the cash as received. The cheque is dishonoured, the bank charges a $35 returned-item fee, and the customer does not settle by transfer until 30 days later. If the supplier finances its working capital at 9% a year, the carrying cost of the delay is $18,500 x 0.09 x 30 / 365 = $136.85. Adding the bank charge gives a total cost of $136.85 + $35 = $171.85, on top of the temporary $18,500 hole in the bank balance and the time spent chasing.Case study
Seen in the real world.
Northbank Timber Supplies is an illustrative, entirely fictional merchant selling to small building contractors on 30 day credit terms. For years it accepted cheques on delivery and treated them as cash, until a quarter in which eleven cheques totalling $96,000 were dishonoured, three of them from the same contractor.
The finance manager worked out that each dishonoured cheque cost roughly $180 in bank fees and financing, and far more in wasted collection time. She changed the policy so that cheques above $5,000 had to clear before goods were released, and any customer with two dishonoured payments in a rolling year moved to card payment on collection.
Over the next two quarters dishonoured payments fell to two, worth $9,400 in total, and the average time between delivery and cash in the bank shortened by six days. The illustrative lesson is that dishonour is rarely random; it clusters around a handful of customers whose credit terms should have been tightened earlier.
Watch out
Common mistakes.
- Treating a cheque deposit as cash received. Until the funds have cleared, the money is provisional, and a dishonoured cheque reverses the whole entry.
- Forgetting to reinstate the receivable, so the customer disappears from the ageing report and nobody chases the debt.
- Absorbing bank charges silently instead of recharging them where the contract allows and tracking them by customer, which hides the true cost of poor payers.
Questions
People also ask.
What is the difference between a dishonoured payment and a bad debt?
Dishonour means a specific payment failed, while a bad debt means you have concluded the amount will never be collected at all.
Can a payment be dishonoured even when the payer has the money?
Yes, for example if the payer instructs the bank to stop the payment, the account details are wrong, or the instrument is stale-dated.
Does dishonour affect the payer's credit standing?
It can, because banks and trade credit insurers record returned payments, and a pattern of them usually leads to tighter terms or a reduced credit limit.
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