What it means
In international trade, a seller often agrees to be paid some weeks after the goods arrive instead of immediately. The agreed delay is the usance period, and the document that records the promise to pay is typically a bill of exchange, a written order for the buyer to pay a stated amount on a set date.
Common usance periods are 30, 60, 90 or 180 days. A bill that must be paid on presentation is called a sight bill, and one that allows a delay is called a usance bill.
The buyer gets time to receive the goods, sell them and collect cash before paying. This can be the difference between a buyer being able to place an order and not.
The usance period is counted in different ways. It may run from sight, meaning the day the buyer sees and accepts the bill, from the date of the bill or from the date of shipment.
The wording matters because it fixes the exact day payment is due. Usance can be financed.
A seller who cannot wait 90 days for payment may sell the accepted bill to a bank at a discount, receiving cash now in return for giving up some of the face value. In a usance letter of credit, the bank may pay the seller on delivery of documents and let the buyer pay the bank later, with the buyer bearing the interest cost.
For a finance manager, the usance period has a direct effect on working capital, the cash tied up in day-to-day trading. A longer usance helps the buyer's cash flow but hurts the seller's, so the period is often a negotiating point alongside price.
The interest or discount cost of the extra days should be built into pricing. Documentation needs care.
The bill must clearly state the amount, the due date and who accepted the obligation, and an accepted bill from a well-rated bank is easier to sell than one signed by a small buyer. Weak paperwork can delay payment or make the bill difficult to discount.
In practice
Real-world examples.
Example
A textile exporter in Sri Lanka ships garments to a retailer in Europe on a 60-day usance bill. The retailer sells the goods in 45 days and pays on the due date from the proceeds.
Example
A machinery importer asks its bank to open a usance letter of credit for 120 days. The bank pays the overseas supplier at shipment and the importer pays the bank four months later, plus interest.
Example
A coffee trader receives a 90-day accepted bill from a roaster. Needing cash for the next harvest, it sells the bill to its bank at a discount and receives most of the value immediately.
Formula
Calculation
Usance interest cost = bill amount x annual interest rate x (usance days / 360)
Suppose an importer owes $500,000 on a bill with a usance of 90 days and the bank charges 6% a year. The cost is 500,000 x 0.06 x (90 / 360) = 500,000 x 0.06 x 0.25 = $7,500. The importer pays $507,500 in total if the interest is added at maturity. A seller who sells the bill early receives $500,000 less the bank's discount. Some markets use a 365-day year instead of 360.Case study
Seen in the real world.
Brightwater Imports is an illustrative, fictional company that buys $2,400,000 of kitchenware a year from an overseas manufacturer. At present it pays on shipment, which ties up a large amount of cash in stock.
The finance director negotiates a 90-day usance with the supplier, who agrees if the price rises by 1.2%. The extra cost on annual purchases is 2,400,000 x 0.012 = $28,800.
In this illustrative story the director compares that cost with the benefit of freeing about $600,000 of cash for a quarter, which would otherwise require an overdraft costing more. She accepts the usance and uses the freed cash to reduce borrowing.
Watch out
Common mistakes.
- Confusing usance with interest, when usance is the length of time allowed and interest is the cost of that time.
- Counting the days from the wrong starting point, such as the shipping date instead of the date of acceptance.
- Ignoring the cost of extended payment terms, which is built into the price or charged as interest.
Questions
People also ask.
What is a sight bill?
It is a bill payable immediately when it is presented, so it has no usance period.
Who pays the cost of usance in a letter of credit?
It depends on the agreement, and in some cases the buyer pays the interest while in others the seller bears the discount.
How long is a typical usance period?
Periods of 30, 60, 90 and 180 days are common, although the right length depends on the goods and the market.
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