Cheques and demand drafts (DD) are two common financial instruments used for payments in India. While both serve the purpose of transferring funds, it’s important to understand the difference between DD and cheque for effective financial management. Knowing the distinct features of each can help you decide which option is more suitable for your transactions.
Related Read: What is a Bank Cheque Book?
Table of Contents
Difference Between Cheque and Demand Draft
Aspect |
Cheque |
Demand Draft |
|
Definition |
A written instrument directing a bank to pay a specific amount to a person or bearer |
A prepaid instrument issued by a bank to transfer money to a specific person or entity |
|
Issuing Authority |
Individual or Business |
Bank or Financial Institution |
|
Payment Process |
Funds debited from the issuer’s account |
Prepaid by the purchaser |
|
Payment Guarantee |
Subject to funds available in the issuer’s account |
Payment guaranteed by the issuing bank |
|
Payment Mode |
Can be deposited or encashed at the bank |
Payable at any branch of the issuing bank |
|
Fee or Charges |
No additional charges (unless bounced) |
Issuance fee may apply depending on draft value |
|
Risk of Bounce |
Higher risk if funds are insufficient |
Lower risk as funds are prepaid |
|
Validity |
Typically 3 months from the date of issue |
Typically 3 months from the date of issue |
|
Processing Time |
Varies based on bank’s process |
Generally faster than cheques |
|
Use Cases |
Personal payments, bill payments, etc |
Large transactions, fund transfers, etc |
|
Security |
Risk of fraud if lost or stolen. |
More secure as funds are prepaid |
Real-World Implications:
1. Cheques
Cheques are used for personal payments and bill payments. However, they carry a higher risk of bouncing if the issuer’s account lacks sufficient funds, which can lead to delays and additional charges.
2. Demand Drafts
Demand drafts are preferred for large transactions and fund transfers due to their guaranteed payment and lower risk of bouncing. They are also more secure as the funds are prepaid, reducing the risk of fraud.
What is a Cheque?
A cheque is a bill of exchange, where an account holder (drawer) instructs their bank (drawee) to pay a specified amount to a designated person or entity (payee). It is a negotiable instrument, governed by the Negotiable Instruments Act, 1881.
Cheques can be issued from both savings and current accounts. Serving as a secure and formalized method of payment, cheques provide a convenient alternative to cash transactions, facilitating smooth and documented fund transfers in personal and business dealings.
Key Features of a Cheque
1. Unconditional Order from the Account Holder
A cheque is a direct and unconditional order from the account holder (drawer) to the bank. This means the bank is obligated to pay the amount mentioned without any conditions or additional permissions from the drawer.
2. Issuance by Account Holder
Cheques can only be issued by individuals or businesses that hold specific types of bank accounts, such as Savings, Current, Cash Credit, or Overdraft accounts. This ensures that the drawer (account holder) has a legitimate account with the bank.
3. Irrevocable Payee Information
Once the payee’s name is written on the cheque, it cannot be changed or altered. This provides certainty that the payment will reach the intended recipient. This feature adds security and prevents any unauthorized redirection of funds.
4. Fixed Payment Amount in Numbers and Words
The amount mentioned on the cheque is fixed and written both in numbers and words (e.g., ₹5,000 and “Five Thousand Rupees Only”). Once the amount is written, it cannot be altered. This ensures that the exact sum is paid to the payee, leaving no room for disputes or fraud. If any alterations are made, the cheque could be rejected by the bank.
5. Sufficient Funds Requirement for Transfer Completion
To avoid a cheque bounce, the drawer must have sufficient funds in their account to cover the amount mentioned on the cheque. For example, if you issue a cheque for ₹50,000, but your account balance is only ₹30,000, the cheque will bounce, leading to penalties and legal consequences.
Types of Cheques
1. Order Cheque
- Order Cheque is payable only to the person or entity whose name is mentioned on the cheque. The payee must provide identity proof when presenting it to the bank for encashment.
- Order cheque provides an extra layer of security, ensuring that only the designated individual can claim the funds. For example, a business might use an order cheque to pay a vendor, ensuring that only that vendor can encash it.
2. Bearer Cheque
- Bearer Cheque is payable to whoever presents them at the bank, meaning no identity verification is needed. This makes them easily transferable and negotiable.
- Bearer Cheques are less secure since anyone in possession of the cheque can encash it, making them prone to theft or loss. Bearer cheques are less common today due to the increased risk.
3. Crossed Cheque
- Crossed Cheque has two parallel lines drawn across the top corner, usually with “account payee” written between them. This ensures that the cheque can only be deposited into a bank account and cannot be encashed over the counter.
- Crossed Cheques provide greater security, making them the preferred option for business payments where funds need to be transferred directly to the payee’s account.
4. Post-Dated Cheque
- Post-Dated Cheque has a future date mentioned on it, meaning the cheque cannot be encashed until that specific date. They are commonly used in transactions where the drawer wants to ensure that funds will be available on a future date.
- For example, businesses might issue post-dated cheques for paying suppliers on a specified future date to manage their cash flow better.
Pros of Using a Cheque
1. Convenience of Alternative Payment
Cheques allow payer to make payments without needing physical cash, offering a safe and simple alternative for transactions
2. Payment Flexibility Through Post-Dated Cheques
Cheques can be used for various types of payments, including personal, business, or third-party transactions. They allow payments to be scheduled, such as with post-dated cheques
3. Record-Keeping for Official Purpose
Cheques provide a clear paper trail for both the payer and the payee, which can be helpful for managing finances, audits, and tax filing
4. Security of Transaction
Crossed and order cheques provide a higher level of security, ensuring payments reach the intended recipient’s bank account
5. Non-Immediate Payment
Cheques allow you to issue payments that will be processed later, giving time for funds to accumulate in the account
Cons of Using a Cheque
1. Clearance Time
Cheque processing can take several days, delaying the receipt of funds for the payee compared to electronic transfers
2. Risk of Fraud
Cheques, especially bearer or open cheques, can be vulnerable to forgery or theft if lost or stolen
3. Inconvenience
Writing and depositing cheques can be cumbersome, requiring physical handling, especially when compared to online payment methods
4. Cheque Bounce
If insufficient funds are available, cheques can bounce, leading to penalties for the drawer and potential damage to business relationships
5. Geographical Limitations
Some cheques, such as banker’s cheques, are restricted to a specific city or region, limiting their usability
What is Demand Draft?
A demand draft (DD) is a financial instrument used to securely transfer money between bank accounts, issued exclusively by banks. Unlike a cheque, a demand draft is a prepaid instrument. The bank issues a DD only when the drawer has sufficient funds, ensuring secure transactions.
Demand drafts are payable on demand and can only be deposited in a bank, not cashed by the bearer. The drawer requests the DD, the drawee is the bank, and the payee is the recipient, making them ideal for large transactions or when trust is required.
Key Features of a Demand Draft
1. Prepaid Nature Reduces Risk of Availability of Funds
A demand draft is a prepaid instrument, where the requestor must pay the bank the full amount in advance, reducing the risk of insufficient funds
2. Payment Guarantee to the Payee
Since the bank collects the money upfront, a demand draft carries a guaranteed payment to the payee
3. Non-Negotiable After Drafting
Demand drafts are payable only to the person or entity whose name is written on the draft, reducing the risk of misuse or fraud
4. Fixed Amount Specified in Demand Draft
The amount specified in a demand draft is fixed and cannot be altered once issued, ensuring clarity and security in transactions
5. Validity Period
A demand draft is valid for a specific period, usually three months from the date of issue, after which the purchaser may need to request revalidation or a new draft.
Types of Demand Draft
1. Sight Demand Draft
Sight Demand Draft is payable on demand and the payee can claim the payment as soon as they present it at the bank. This type is commonly used for quick and immediate payments, making it suitable for transactions where promptness is required.
2. Time Demand Draft
Time Demand Draft is payable only after a specified period, providing more control over the timing of payments. It is typically used in business transactions where the payee agrees to receive the payment after a certain period. This type is preferred when parties want to schedule payments for a future date, allowing for better financial planning.
Pros of Using a Demand Draft
1. High Level Payment Security
Demand drafts offer a high level of payment security as the bank guarantees the amount. The payee does not need to worry about insufficient funds or cheque bounces.
2. Prompt Payment Process due to Prepaid Nature
Since the funds are already paid to the bank, the payment process is quick, especially with sight drafts, where the payee can claim the funds immediately upon presentation.
3. Reduced Fraud Risk as it is Non Negotiable
Demand drafts are non-negotiable, and the person or entity named in the draft can encash it, reducing the risk of fraud or misuse.
4. Wide Acceptance For Any Form of Payment
Demand drafts are widely accepted by businesses, educational institutions, and government agencies, making them a trusted form of payment in various sectors.
Cons of Using a Demand Draft
1. Increased Cost due to Bank Issuing Charges
Banks charge a fee for issuing demand drafts, increasing the overall amount of the draft. This makes it less cost-effective for frequent or small-value transactions.
2. Limited Usage due to Nature of Transactions
Demand drafts are mostly used for larger transactions or payments where security is essential. For smaller or routine payments, cheques or electronic transfers are often preferred due to their convenience.
3. Non-Refundable Once it is Drafted
Once issued, demand drafts are generally non-refundable. If a draft is lost or stolen, the process to stop payment and request a new draft can be time-consuming and may incur additional costs.
4. Inconvenience due to Time Taken to Process
Unlike electronic transfers, which can be processed instantly online, demand drafts require physical issuance and presentation at the bank, making them less convenient for digital-first users.
How Cheques and Demand Drafts are Similar?
1. Bank Involvement
Both cheques and demand drafts are processed through banks. An account holder issues a cheque, while a demand draft is issued directly by the bank on behalf of the payer. In both cases, the bank plays a central role in ensuring the payment is made securely.
2. Payment Authorisation
In both instruments, the payment is authorised by the payer but facilitated by the bank. With a cheque, the drawer’s signature authorises the bank to release funds, while with a demand draft, the payer must provide funds upfront to the bank, which then guarantees the payment.
3. Record-Keeping
Cheques and demand drafts provide a clear record of transactions. Banks maintain detailed records of both cheque and demand draft issuances and payments, which is useful for accounting, audits, and financial tracking.
4. Alternative to Cash
Both cheques and demand drafts offer a non-cash method for making payments, reducing the risks associated with carrying large sums of money. They are convenient for transferring large amounts securely.
Conclusion
Cheques and demand drafts serve as essential financial instruments, but differ in key aspects. Cheques offer flexibility and convenience but come with the risk of bouncing, while demand drafts ensure guaranteed payments, making them more secure. Cheques work best for everyday transactions, whereas demand drafts are suited for high-value or secure payments.
Although digital payments are becoming the norm, cheques and demand drafts still serve as reliable alternatives for those who prefer paper-based transactions.
Frequently Asked Questions
1. Can you use both cheques and demand drafts for payments?
Yes, both cheques and demand drafts can be used for payments. Cheques are more common for personal and business transactions, while demand drafts are often used for secure payments, especially when the payee needs guaranteed funds.
2. Which instrument offers more security, a cheque or a demand draft?
A demand draft offers more security than a cheque. Since the bank prepays demand drafts, there’s no risk of bouncing due to insufficient funds, unlike cheques, which depend on the balance in the drawer’s account.
3. Do cheques and demand drafts need clearing time?
Yes, both need clearing time, but cheques generally take longer to clear than demand drafts.
4. Which is better, a cheque or a demand draft?
The choice depends on the situation. Cheques are convenient for everyday transactions and do not usually incur fees. Demand drafts are better for high-security payments, especially when guaranteed payment is required, as the bank issues them with no risk of bouncing.
5. Can you get a demand draft without having a cheque?
Yes, you can obtain a demand draft without having a cheque. You can directly request a demand draft from your bank by paying the required amount and any applicable fees.
6. Can I cancel or stop a demand draft?
Yes, demand drafts can typically be cancelled by the purchaser. To do this, promptly contact the issuing bank, submit a written request, and pay any applicable cancellation fees. The bank will then guide you through the process.
