Excerpted from "What Every Banker Needs to Know About Working Capital Lending"
Each stage of the supply chain is evidenced by some form of paperwork. Paperwork that carries a
definable monetary value whose rights can be transferred to a third party is defined as
commercial paper.
Commercial Paper
There are varying types of commercial paper such as:
- Chattel paper, which involves the distribution of goods across state and/or country lines.
- Evidences of indebtedness from one merchant to another, commonly known as a receivable to the
seller and a payable to the buyer.
- Warehouse receipts evidencing inventory that is being stored in definable quantities
with a market price in a secure location.
Commercial paper continues to evolve as an explosion in the electronic World Wide Web has come to play a
bigger role in the supply chain.
Credit Quality
Most lenders think it would be an administrative nightmare to apply
customary credit criteria to commercial paper such as accounts receivable. Therefore, they do not take
such precautions even though credit evaluations occur in every other type of lending.
Normal procedures of determining a credit score should be applied to the commercial paper securing a
working capital loan as wel. Of course the implementation of such a credit criteria would need to be
automated since the credit score would be different on each piece of commercial paper since the
transactions that occur between the participants all have varying credit quality.
Commercial paper is highly liquid. By its nature, it relates to transaction flows that
usually involve days, sometimes months, and very rarely, years. Because these assets are considered
very liquid, they tie very well with short-term lending programs. Ideally, a company who is trying to
eliminate their cash flow gap will use short-term liquid assets to deal with the cash flow gap and support
and sustain the long-term viability of the business with infrastructre related loans to land, building
and equipment that are focused on long-term objectives.
This combination of short-term versus long-term assets in securing working capital transactions creates
challenges for some businesses because lenders tend to disregard commercial paper or highly liquid collateral
as a viable asset to secure a short-term transaction because of the perceived administrative nightmare of
securing the process.
Ideally, lenders would give more emphasis on securing their working capital based loans with liquid
collateral and support the overall relationship with a particular borrower with long-term collateral as
ancillary collateral to the transaction.
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