Definition of Commercial Papers

Commercial papers are negotiable financial instruments that contain an obligation to pay a specific amount of money at a designated time or on demand, and are used as a means of payment or credit in commercial transactions. These papers are characterized by ease of trading and transfer between commercial parties, making them an important tool for facilitating trade and providing liquidity for businesses. Commercial papers are subject to the Saudi Commercial Papers Law and require specific legal conditions to ensure their validity and enforceability.

Basic Types of Commercial Papers

Commercial papers vary according to the nature of obligation and participating parties, with each type having distinctive legal and financial characteristics:

• Bill of Exchange: A written order from the drawer to the drawee to pay a specific amount to the beneficiary on a specified date or at sight, widely used in international and domestic trade

• Promissory Note: A written promise from the debtor to pay a specific amount to the creditor on a specified date, characterized by having only two parties (maker and payee)

• Check: A written order from the customer (drawer) to the bank (drawee) to pay a specific amount to the beneficiary from the drawer's account, considered an immediate payment instrument

• Negotiable Certificates of Deposit: Documents proving deposit of an amount in the bank for a specified period with certain interest, tradable before maturity date

• Electronic Commercial Papers: Digital versions of traditional papers that carry the same legal force with advantages of speed and security

Practical Example of Commercial Papers

A contracting company in Riyadh uses commercial papers in its operations as follows:

Date: March 2025

• Bill of Exchange for Suppliers: Issuing a bill of exchange worth SAR 500,000 for material supplier due within 90 days
• Promissory Note from Client: Obtaining a promissory note worth SAR 1.2 million from client for completed project
• Checks for Employees: Issuing monthly salary checks worth SAR 450,000
• Paper Discounting: Discounting the promissory note at the bank with 6% interest to obtain immediate liquidity
• Calculated Interest: SAR 18,000 for 3 months (1,200,000 × 6% ÷ 4)

Importance of Commercial Papers in Business

Commercial papers play vital roles in the financial and commercial system and provide multiple advantages for businesses:

• Facilitating Commercial Transactions: Provide flexible and secure payment methods that facilitate commercial exchange without need for immediate cash payment, improving cash flow for companies

• Providing Commercial Credit: Enable companies to obtain goods and services with deferred payment, helping in efficient working capital management

• Quick Financing Possibility: Commercial papers can be discounted at banks to obtain immediate liquidity before maturity date, providing financial flexibility

• Legal Guarantee: Enjoy strong legal protection ensuring creditors' rights and effective collection methods in case of non-payment

• Reducing Cash Handling Risks: Reduce risks of carrying and handling cash and provide clear audit trail for financial transactions

Legal Characteristics of Commercial Papers

Commercial papers are distinguished by unique legal characteristics that differentiate them from ordinary documents:

• Negotiability: Ownership can be transferred from one person to another through endorsement or delivery, making them flexible instruments for financing and trade

• Independence: Each party signing the paper assumes independent obligation regardless of other parties' obligations

• Abstraction: The obligation contained in the paper is separate from the original reason for its creation, protecting the rights of holder in good faith

• Quick Execution: Provide simplified and fast execution procedures compared to ordinary debts

• Formality: Require specific formal conditions to ensure legal validity such as signature, date, and amount

Accounting Treatment of Commercial Papers

Commercial papers are recorded accounting-wise in different ways according to their type and the company's role:

• Received Commercial Papers: Recorded as assets in the balance sheet under "Notes Receivable" and represent debts owed by others

• Issued Commercial Papers: Recorded as liabilities under "Notes Payable" and represent obligations on the company

• Discounting Commercial Papers: Recorded as borrowing operation secured by the commercial paper with calculation of discount interest

• Interest and Commissions: Calculated and recorded according to accrual principle in the appropriate accounting period

Common Challenges in Commercial Papers Management

Despite the multiple advantages of commercial papers, their management faces various challenges requiring specialized expertise and strict control systems. These challenges arise from the complex legal nature of commercial papers, market risks, and technical and human factors. Understanding these challenges and developing strategies to deal with them is necessary to ensure safe and effective utilization of commercial papers. The most prominent of these challenges include:

• Default Risk: Possibility of debtor's inability to meet obligations on maturity date, requiring accurate credit assessment

• Legal Complexities: Need to comply with strict legal conditions to ensure validity and enforceability of papers

• Managing Dates and Maturities: Precise follow-up of maturity dates and collection procedures to avoid losing rights

• Forgery and Fraud: Risks of manipulation in commercial papers and need for strong security controls

• Interest Rate Fluctuations: Affect the cost of paper discounting and their market value