Meaning
Financial contract that grants a lender control over a borrower’s bank account to ensure the direct collection of proceeds from collateral. This instrument governs the flow of cash from accounts receivable or asset sales into a specific account where the bank follows the lender’s instructions. It stops applying once the underlying debt is satisfied or the lender formally releases its security interest.
Control Mechanism
Practical authority over the funds is established by notifying the bank that the lender has the right to direct disbursements. This blocked account agreement ensures that the borrower cannot withdraw money without the explicit consent of the financing party. It answers the readiness question of whether the cash cycle is fully secured against unauthorized diversion.
Production yields from a factory are effectively worthless as collateral if the resulting cash cannot be captured by the lender.
Waterfall Structure
Funds entering the account are typically distributed according to a predetermined sequence known as a waterfall. This process prioritizes debt service and operating expenses before any surplus is returned to the borrower. The audit that measures the effectiveness of this system is the daily reconciliation of incoming wire transfers against the loan balance.
Calling a default early based on a temporary dip in cash flow can disrupt the supplier relationship and halt production.
Operational Buffer
Companies often negotiate for a certain amount of liquidity to remain accessible for daily needs. This carve out allows for the payment of wages and utilities without requiring a specific release for every transaction. The size of this buffer is measured against the demonstrated rate of expenses rather than a simple forecast.
