Asset-Based Financing Basics: What CPAs Need to Know about Using Asset-Based Lending and Factoring as Alternatives to Traditional Bank Financing
EXECUTIVE SUMMARY * A revolver is a secured line of credit. The granting of the security interest to the lender creates a borrowing base for the loan. As receivables are collected, the money is used to pay down the loan balance. * A "lockbox" or a "blocked account" is established by the lender for the receipt of collections of the accounts receivable. The company's customers are instructed to pay their accounts to the lockbox, and the lender pays down the loan with these funds. * Eligible inventory includes finished goods and marketable raw materials and excludes work-in-process and slow-moving goods. There could be additional limits on the advance rate for specially manufactured goods that can only be sold to a specific customer. * Purchase order financing can be used by companies that receive an unusually large order. The credit grantor accepts the purchase order from the company's customer as collateral for the loan. * Factoring is a financial transaction whereby a business sells its accounts receivable to a third party, the factor, at a discount to obtain cash. Factoring differs from a bank loan in three ways: (1) The emphasis is on the value of the receivables, not the borrower's creditworthiness; (2) factoring is not a loan-it is the purchase of the receivable; and (3) a bank loan involves two parties whereas factoring involves three. ********** [ILLUSTRATION OMITTED] Once considered financing of last resort, asset-based lending and factoring have become popular choices for companies that do not have the credit rating or track record to qualify for more traditional types of financing. In general terms, asset-based lending is any kind of borrowing secured by an asset of the company This article will consider asset-based lending to mean loans to businesses that are secured by trade accounts receivable or inventory Asset-based lenders focus on the quality of collateral rather than on credit ratings. Borrowers pledge receivables, inventory and equipment as collateral. Traditional bank lenders may have significant problems with asset-based loam. Banks are constrained by both internal credit granting philosophies as well as federal regulations. Banks typically do not accept transactions with debt-to-worth ratios higher than four or five to one. Asset-based lenders that are either nonbanks or separate subsidiaries of banks are not subject to such constraints. This gives asset-based lenders the freedom to finance thinly capitalized companies. REVOLVING LINES OF CREDIT (REVOLVERS) A revolver is a line of credit established by the lender for a maximum amount. Revolvers are used by retailers, wholesalers, distributors and manufacturers. The line of credit typically is secured by the company's receivables and inventory It is designed to maximize the availability of working capital from the company's current asset base. A typical term for a revolver is one to three years or longer. The borrower grants a security interest in its receivables and inventory to the lender as collateral to secure the loan. In most cases, lenders require personal guarantees from the company's owners. The security interest creates a borrowing base for the loan. As receivables are collected, the money is used to pay down the loan balance. When the borrower needs additional financing, another advance is requested. The borrowing base consists of the assets that are available to collateralize a revolver. It generally consists of eligible receivables (defined below) and eligible inventory The size of the borrowing base varies with changes in the amounts of the borrower's current assets limited to the overall revolving line of credit. AS the borrower manufactures or acquires new inventory, and as it generates receivables from sales, these new assets become available for inclusion in the borrowing base. The borrowing base certificate is a form prepared by the borrower and submitted to the lender periodically (usually monthly). …