Asset-Based Financing Basics

Sterling Commercial Credit Asset Based Financing

March 2014

Asset-based lending was once considered the least preferred among all the traditional financing options but is fast gaining popularity now. Asset-based lending has become a favourable choice for companies that do not enjoy a track record or credit rating sufficient to qualify for other type of financing.

Generally speaking, asset-based lending refers to borrowing against assets of the company that can either be inventory, equipment or trade account receivables. The financial institutions offering this kind of lending focus on the quality and value of the collateral instead of the credit ratings or track record of the business and company. Traditional banks tend to have an aversion to asset based loans simply because they are bounded by internal lending policies and government regulations.

If the debt-to-worth ratio is more than four or five to one, banks prefer not to accept such transactions. Financial institutions that are subsidiary of banks or work independently do not have such constraints and enjoy the freedom to lend even to small capital companies.

Revolving Lines of Credit (Revolvers)

The lender can set a line of credit for the maximum amount which is called a Revolver. This line of credit is generally secured by granting a security interest in the inventory or receivables of the company that is pledged as collateral for the loan. This creates a borrowing base for the loan.

Use of a Lockbox

A ‘lockbox’ or a ‘blocked account’ is set up is generally created at the bank where the borrower does business. The asset-based lender gets the control of the incoming cash receipts from the company’s customers through a security agreement.

Eligible Assets

There are certain receivables that are not considered in the borrowing base like receivables that are more than 90 days old, slow-moving goods and work-in-process goods. The advance rate is set is by the lender and that dictates the amount that can be borrowed. Dilution of receivables plays an important role in deciding this advance rate.

Purchase Order Financing

Companies that have limited working capital can use purchase order financing in case where there is a huge order by a customer that will need additional funding for material, labor and supply costs. The purchase order acts as the collateral for the loan in these cases.

Factoring

Factoring is a form of financial transaction where a third-party comes into play which is called the ‘factor’. The company sells its accounts receivables to this third party for a discount and obtains cash. Factoring is not a loan as it involves sale of receivables and there are three parties involved in the process. This implies that the factor gets complete control over the receivables along with all the risks associated.