|Finally It’s Time to Have a New Take at Asset Based Lending
There are numerous misperceptions amongst CFOs and finance executives when it concerns asset-based lending. The greatest is that asset-based lending is a financing alternative of last hope – one that only “desperate” companies that can’t get a traditional bank loan or line of credit would think of.
With the economic recession and resulting credit crunch of the past few years, though, many companies that might have gotten more traditional types of bank financing in the past have now relied on asset-based lending. And to their wonder, many have discovered asset-based lending to be a flexible and cost-effective financing instrument.
What Asset-Based Lending Looks Like
A normal asset-based lending scenario often looks something similar to this: A business has gotten through the recession and financial crisis by aggressively managing receivables and inventory and delaying replacement capital spending. Since the economy is in recovery (albeit a weak one), it will need to build up working capital to fund new receivables and inventory and fill new orders.
Sadly, the business no longer qualifies for traditional bank loans or lines of credit due to high leverage, deteriorating collateral and/or extreme losses. From the bank’s perspective, the business is no longer creditworthy.
Even businesses with strong bank relationships can run afoul of loan covenants if they experience short-term losses, sometimes forcing banks to rescind on credit lines or drop credit line increases. A couple of bad quarters doesn’t necessarily signify that a business finds themselves in difficulty, but at times bankers’ hands are tied and they’re required to make financing choices they might not have a few years ago, before the credit crunch altered the rules.
In situations like this, asset-based lending can supply much-needed money to help businesses endure the storm. Companies with good accounts receivable and a sound base of creditworthy customers tend to be the most suitable candidates for factoring loans.
With conventional bank loans, the banker is largely interested in the borrower’s projected cash flow, which will provide the funds to repay the loan. That is why, bankers pay especially close attention to the borrower’s balance sheet and income statement so as to evaluate future cash flow. Asset-based lenders, conversely, are mainly worried about the performance of the assets being pledged as collateral, be they machinery, inventory or accounts receivable.
Therefore before lending, asset-based lenders will typically have machinery or equipment independently valued by an appraiser. For inventory-backed loans, they usually need regular reports on inventory levels, together with liquidation valuations of the raw and finished inventory. And for loans backed by accounts receivable, they often perform thorough analyses of the eligibility of the collateral based on past due, concentrations and quality of the debtor base. But not like banks, they typically do not place tenuous financial covenants on loans (e.g., a maximum debt-to-EBITDA ratio).
Asset-Based Lending: The Nuts and Bolts
Asset-based lending is actually an umbrella term that covers several different kinds of loans that are secured by the assets of the borrower. The two primary types of asset-based loans are factoring and accounts receivable (A/R) financing.
Receivable Factoring is the outright purchase of a business’ outstanding accounts receivable by a commercial finance company (or factor). Commonly, the factor will advance the business between 70 and 90 percent of the value of the receivable at the moment of purchase; the balance, less the factoring fee, is released when the invoice is collected. The invoice discounting fee typically ranges from 1.5-3 .0 percent, relying on such things as the collection risk and the amount of days the funds are in use. See Freight Factoring Company Reviews.
Under a contract, the business can usually pick which invoices to sell to the factor. As soon as it purchases an invoice, the factor deals with the receivable until it is paid. The factor will practically become the business’ defacto credit manager and A/R department, ” conducting credit checks, evaluating credit reports, and mailing and documenting invoices and payments.”.
A/R financing, meanwhile, is similar to a standard bank loan, yet with some chief differences. Even though bank loans may be secured by different kinds of collateral including equipment, real estate and/or the personal assets of the business owner, A/R financing is backed purely by a pledge of the business’ outstanding accounts receivable.
Under an A/R financing arrangement, a borrowing base is set up at each draw, against which the business can borrow. A collateral management fee is charged against the outstanding amount, and when funds are advanced, interest is assessed only on the amount of money actually borrowed.
An invoice usually must be under 90 days old in order to count toward the borrowing base. There are frequently other eligibility covenants like cross-aged, concentration limits on any one customer, and government or international customers, depending on the lender. In some cases, the underlying business (i.e., the end customer) must be deemed creditworthy by the finance company if this customer makes up a majority of the collateral. We encourage you to read Freight Factoring Company Reviews online for you to learn more about it.