Accommodation bill

3 key takeaways

• An accommodation bill is used to help one party secure credit, with the accommodating party providing a guarantee without receiving any immediate benefit.
• It is a form of financial assistance, often used in situations where the party needing credit cannot secure it on their own.
• The accommodating party assumes liability for the bill, which means they may have to pay if the original party defaults.

What is an accommodation bill?

An accommodation bill is a financial instrument used to support another party in obtaining credit. This type of bill of exchange is drawn, accepted, or endorsed by a party (the accommodator) who provides their creditworthiness to help the other party (the accommodated) secure funds or credit. The accommodator does this without receiving any direct compensation or value in return at the time of the transaction.

For instance, a company that needs to raise funds might ask another company or individual with a stronger credit rating to accept or endorse a bill of exchange. The accommodating party’s involvement makes the bill more credible and easier to discount or sell to a third party, thus providing the necessary funds to the accommodated party.

Importance of an accommodation bill

Accommodation bills are important in financial markets as they facilitate credit access for parties that might otherwise struggle to secure financing. They are particularly useful for businesses that need temporary financial assistance or support during cash flow shortages. By leveraging the creditworthiness of the accommodating party, the accommodated party can obtain the necessary funds to continue their operations or fulfill their obligations.

How an accommodation bill works

1. Agreement: The accommodated party requests the accommodator to accept or endorse a bill of exchange on their behalf.
2. Issuance: The bill is drawn, and the accommodator accepts or endorses it, providing their guarantee of payment.
3. Discounting: The accommodated party can then sell or discount the bill to a financial institution or third party to obtain immediate funds.
4. Repayment: At maturity, the accommodated party is expected to repay the bill. If they default, the accommodator is liable to pay the amount due.

Examples of accommodation bills

• Business support: A small business that cannot secure a loan on its own might use an accommodation bill, with a larger, more established company acting as the accommodator to help secure the needed funds.
• Family or friend support: An individual might endorse a bill of exchange to help a friend or family member obtain credit, acting as an accommodator without immediate compensation.

Real-world application

Consider a scenario where a startup company needs to purchase inventory but lacks the necessary funds and cannot secure a bank loan due to its limited credit history. The startup approaches a well-established business partner to act as an accommodator. The partner accepts a bill of exchange, allowing the startup to discount the bill at a bank and receive the required funds. The startup then uses the funds to purchase inventory and agrees to repay the bill amount at maturity. If the startup fails to pay, the accommodating business partner will be liable for the payment.

Understanding accommodation bills helps in recognizing the various methods through which credit can be extended and financial support can be provided within the business community. To further explore related concepts, you might want to learn about bills of exchange, credit instruments, and financial guarantees.