Management Notes

Reference Notes for Management

Trust Receipt Loans – Inventory Financing | Short Term Financing

Trust Receipt Loans | Inventory Financing | Short Term Financing | Corporate Finance

Under a trust receipt financing arrangement, the borrower holds in trust for the lender the inventory and the proceeds from its sale. This type of lending arrangement, known also as floor planning, has been used extensively by automobile dealers, equipment dealers, and consumer durable goods dealers, An automobile manufacturer will ship cars to a dealer who, in turn, may finance the payment for these cars through a finance company.

The finance company pays the manufacturer for the cars shipped. The dealer signs a trust receipt security agreement, which specifies what can be done with the inventory. The car dealer is allowed to sell the cars but must turn the proceeds of the sale over to the lender, in payment of the loan. Inventory in trust, unlike inventory under a floating lien, is specifically identified by serial number or by other means. In our example, the finance company periodically audits the cars the dealer has on hand. The serial numbers of these cars are checked against those shown in the security agreement. The purpose of the audit is to see if the dealer has sold cars without remitting the proceeds of the sale to the finance company.

As the dealer buys new cars from the automobile manufacturer, a new trust receipt security agreement is signed, taking account of the new inventory. The dealer then borrows against this new collateral, holding it in trust. Although there is tighter control over collateral with a trust receipt agreement than with a floating lien, there is still the risk of inventory being sold without the proceeds being turned over to the lender. Consequently, the lender must exercise judgment in deciding to lend under this arrangement. A dishonest dealer can devise numerous ways to fool the lender.

Many durable goods manufacturers finance the inventories of their distributors or dealers. Their purpose is to encourage dealers or distributors to carry reasonable stocks of goods. It is reasoned that the greater the stock, the more likely the dealer or distributor is to make a sale. Because the manufacturer is interested in selling its product, financing terms are often more attractive than they are with an “outside” lender.

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