Sight Draft

A Sight Draft is a type of bill of exchange or draft that is payable immediately upon presentation to the party responsible for payment. Think of it as a formal “pay on demand” order, most commonly used in international trade to ensure a seller gets paid promptly. When a seller ships goods to a buyer overseas, they want a guarantee of payment. By using a sight draft, the seller instructs the buyer (or the buyer's bank) to pay the full amount of the sale as soon as the draft is presented to them. The crucial part is that the buyer cannot take legal possession of the shipped goods until this payment is made. This arrangement transfers the payment risk from the seller to the buyer. Unlike a time draft, which allows for payment at a later date (e.g., 60 or 90 days after acceptance), a sight draft demands immediate settlement. This makes it a powerful tool for sellers to control their accounts receivable and minimize the risk of non-payment after goods have already been shipped across the globe.

Imagine an American company, “Texas Tractors,” selling a tractor to a German farm equipment dealer, “Berlin Farm-Supply.” They agree to use a sight draft. The process is a beautifully choreographed financial dance involving documents and banks.

1. Step 1: Shipping and Documentation

Texas Tractors ships the tractor. The shipping company gives them a crucial document called a bill of lading, which acts as the title or deed to the tractor. Without it, Berlin Farm-Supply can't claim the shipment.

1. Step 2: Creating the Draft

Texas Tractors (the drawer) prepares the sight draft for the full purchase price and gives it, along with the bill of lading and other shipping documents (like the insurance policy and invoice), to its bank in Houston.

1. Step 3: Bank-to-Bank Transfer

The Houston bank sends the sight draft and the entire document package to Berlin Farm-Supply's bank in Berlin. The German bank now acts as the collecting agent.

1. Step 4: Presentation and Payment

The Berlin bank notifies Berlin Farm-Supply (the drawee) that the documents have arrived. To get their hands on that precious bill of lading and claim their new tractor from the port, Berlin Farm-Supply must immediately pay the amount stated on the sight draft to their bank.

1. Step 5: Release and Settlement

Once payment is confirmed, the Berlin bank releases the documents to Berlin Farm-Supply. The funds are then wired back through the banking system to Texas Tractors (the payee). The deal is done—Texas Tractors has its money, and Berlin Farm-Supply has its tractor. This process is more secure than simply sending an invoice (open account) but less complex and costly than a letter of credit.

The difference is all about timing, which has huge implications for who holds the financial burden during a transaction.

• Sight Draft: Pay now. Payment is due “on sight” or immediately upon presentation of the draft. The buyer gets the ownership documents after paying. This strongly favors the seller, as it eliminates their credit risk.
• Time Draft: Pay later. Payment is due at a specified future date (e.g., “90 days after sight”). The buyer can “accept” the draft (creating a legal obligation to pay later, known as a banker's acceptance if accepted by a bank) and receive the ownership documents immediately. This provides the buyer with short-term financing, allowing them to potentially sell the goods before the payment is even due. This favors the buyer.

For a value investor, understanding how a company manages its sales and purchases is fundamental. The choice between a sight draft and other payment terms reveals a lot about a company's market position, risk management, and working capital health.

A company that consistently sells its products using sight drafts is likely in a strong negotiating position. It shows that customers need the company's products badly enough to agree to pay immediately, even before inspecting the goods. This practice significantly reduces the seller's risk of bad debt and indicates prudent financial management. Conversely, if you see a company shifting from sight drafts to more lenient terms like time drafts or open account, it could be a red flag. It might suggest they are facing intense competition and have to offer sweeter deals to keep customers, potentially taking on more risk to maintain sales figures.

The payment method directly impacts a company's cash conversion cycle.

• For a Seller: Using sight drafts means cash comes in the door faster, improving liquidity and reducing the need for external financing to cover operational costs.
• For a Buyer: Being required to pay via sight drafts can strain working capital. The company must have cash ready to go, tying up funds that could be used elsewhere. If a company you're analyzing is a buyer that primarily uses sight drafts, you'll want to ensure it has strong cash flow and isn't overly reliant on credit lines to fund its inventory.

Ultimately, a detail as small as a sight draft provides a window into a company's operational reality. It helps you, the investor, look beyond the headlines and understand the nuts and bolts of how a business truly creates—and protects—its value.