What is a Trust Receipt?
A trust receipt is a document that notifies a buyer that goods have been released from a bank, but the bank still owns the title to the released assets. When a trust receipt is involved, the buyer can keep the goods in trust for the bank for production or sales, but the bank retains ownership of the goods.
How Trust Receipts Work
A trust receipt is a financial document that a bank and a company that has received goods delivery but can only pay for them once the inventory is sold has to deal with. Most of the time, other initiatives and business processes may be entangled with the company’s cash flow and working capital.
Typically, businesses buy inventory from wholesalers or suppliers when operating a trading company to make or resell their products to customers. These products might be imported from other businesses or bought locally. The seller or exporter bills these businesses for the things they have acquired when they get the merchandise. If the company does not have enough cash to pay the invoice, it may use a trust receipt to get financing from a bank.
When the products are sold, the trust receipt acts as a promissory note to the bank, guaranteeing repayment of the loan amount. The bank either pays the exporter directly or provides a letter of credit to the seller or seller’s bank, guaranteeing payment for the goods. As collateral, the merchandise’s title is still held by the lender. In essence, the client or borrower retains and sells the items as a trustee on behalf of the bank and is obliged to maintain them apart from its other inventory.
The client receives ownership of the items and is free to do with them as they want, provided that they don’t break any conditions of their agreement with the bank, even if the bank has a security interest under the standard provisions of a trust receipt. The client may tender the amount lent on the products and take complete possession of them if they want to cease the bank’s security interest and attach it to the inventory.
A Trust Receipt Example
The firm often needs more assets for specific items funded under a trust receipt transaction. The bank bears most of the credit risk associated with the transaction. The company assumes the business risk in addition to keeping any earnings from the resale of the products.
The firm is responsible for any damage, loss, or degradation in quality or value to the items, and it is still accountable for repaying the bank for the whole amount borrowed. In addition, the firm, not the lending institution, is accountable for all business expenses (such as production costs, freight, customs fees, storage, etc.).
Particular Points to Remember
To use a trust receipt to extend short-term borrowing, the borrower or client must be in good standing with the bank. The trust receipt’s parameters, which include the funding amount, interest rate, and maturity date, must also be approved by the bank and the client.
Trust receipts have short maturity periods, ranging from 30 to 180 days. When the loan matures, the borrower must pay the lender the amount borrowed plus interest as specified in the trust receipt. Repayment to the bank is due at maturity or upon the sale of the goods, whichever occurs first. The bank may seize and dispose of the goods if, after the maturity date, it has not received any payment or if the company doesn’t pay back its loans.
A Trust Receipt Transaction: What Is It?
When a business lacks the funds to buy goods, a bank may use a trust receipt transaction to lend the business the money it needs while keeping ownership of the assets. The agreement states that the business will reimburse the bank after the goods are sold.
What distinguishes a trust receipt from a letter of credit?
A letter of credit, widely used in the commercial sector, is a promise from a bank that the buyer will complete the payment and provide it to the seller. On the other hand, a trust receipt is issued when a bank loans money to a company but keeps ownership of the products. The firm acquires ownership of the products when sold, and the bank has been paid.
What takes place when a trust receipt is broken?
When the borrower does not return the products they borrowed or does not return the earnings from the sale of the goods under the terms of the agreement, a trust receipt is breached.
It is a notification that goods have been released from a bank to a buyer, but the bank still owns the items.
Conclusion
- Companies that trade in pricey, durable items, automobiles, or equipment are often parties to these agreements.
- The buyer may keep the goods in trust for the bank for manufacture or sales, but the bank retains ownership.
- This kind of agreement is often called a letter of credit financing. When the products are sold, the trust receipt acts as a promissory note to the bank, guaranteeing repayment of the loan amount.
