Open Account: a Worked Example

Most domestic sales between businesses already run on credit terms, and a lender reads those through the aged debtors report and debtor days. The term earns particular attention in export, because the buyer sits under another legal system, may be hard to research, and holds goods that nobody can realistically fetch back.

Three things go when a buyer moves from a letter of credit to open account. The obligor changes, from a bank to a company. Control of the goods goes, because the shipping documents travel to the buyer without a bank holding them. And the checkpoint goes: nobody examines anything before the goods are released. The US Department of Commerce ranks open account among the riskiest choices an exporter can make, and the UK government's export guidance reserves it for customers the seller trusts highly. Neither is saying it is wrong. It is often the commercial price of keeping a good buyer. They are saying what the seller has taken on.

The contract fixes when the clock starts, and a term of 60 days from invoice, from shipment or from the end of the month are three different loans. The seller's protections are then bought or negotiated one by one. Trade credit insurance pays a share of a valid claim up to a limit the insurer sets for each buyer. Retention of title keeps ownership with the seller until payment, though whether it holds depends on the law where the goods end up and on the goods still being identifiable. A standby letter of credit can sit behind the trade as a fallback. Invoice finance or an outright sale of the receivable turns the debt into cash, at a price set by the buyer's standing.

Each protection has its own limits, so the lender's question is how much of the balance each one really reaches. Many receivables financiers will not count an overseas debt at all unless it is insured, and country lists differ from one financier to the next.

A maker of commercial lawn equipment, constructed for this page like every figure in it, sells US$6.0m a year to its largest overseas distributor and earns EBITDA of US$2.1m across the business. For years the distributor has bought under sight letters of credit, and cash has arrived about 12 days after shipment. It now asks for 60 days open account, and the exporter's own record with similar buyers suggests payment at about day 72. Shipments peak in spring. The insurer offers a limit of US$1.0m on this buyer at 90% cover, and the lender advances 80% of insured balances. Those levels are the example's, not a market norm.

The saving on letter of credit fees belongs mostly to the buyer. The exporter carries US$0.99m more on average and the interest on it. The larger number is the US$0.70m: one customer's failure at the wrong moment would take a third of a year's EBITDA. The insured limit also leaves a gap in the funding. At the peak the exporter holds a US$1.60m debt against which the lender will advance US$0.80m, so the other half comes from somewhere else. A rising limit, a shorter term in spring or a smaller share of the distributor's orders each changes those lines. Issue 13 puts the same kind of request in front of the reader.

A documentary collection still uses banks to hold the shipping documents until the buyer pays, or signs a bill under documents against acceptance. The bank promises nothing, but the goods do not move until the buyer has done something. Open account has no such step. Under a letter of credit a bank has promised to pay against documents, which is why its applicant pays fees and ties up a limit.

Consignment is further along the same road. The goods reach the buyer or its agent while the seller still owns them, and payment follows only when they are sold on. Open account at least has a sale and a fixed date. Cash in advance sits at the opposite end, with all of the risk on the buyer.

DEFINED IN ONE PARAGRAPH → · HOW BANKS READ EXPORTERS → · TRADE CREDIT INSURANCE →

The first request is usually the ledger split by settlement method, with contractual and actual days beside each. The line a lender watches is uninsured open account, because a business can reach it gradually, one concession at a time, while total debtors look unremarkable. A buyer the insurer has declined is information too: another professional reader has looked at the name and said no.

An insurance policy is only as useful as its conditions. Policies commonly require overdue accounts to be reported and shipments to stop once a buyer is past a set point, and a claim can fail if they were not followed. A lender relying on the cover therefore asks to be named on the policy or to have the proceeds assigned, and reads the policy terms beside the facility letter. Limits can also be reduced or withdrawn for future shipments, so a lender that sized its advance on today's limit has to know what happens the day it falls.