Could an Asset-Based Loan Solve Your Financing Challenges?
Despite the improving economy and credit environment, there are many mid-sized firms that still have a hard time qualifying for traditional bank loans and lines of credit. An asset-based loan can be advantageous for companies that often include fast-growth businesses, businesses with heavy seasonal inventory needs, businesses experiencing temporary cash flow lags or financial difficulty, and businesses that are already highly leveraged.
Manufacturers and distributors, in particular, can experience cash flow crunches as they wait for payment from customers that can sometimes stretch out to 60 to 90 days or even longer. Service providers aren’t immune, either — they can hit cash flow lags between the time when they have to pay salaries and other overhead and the time when they collect outstanding accounts receivable.
An Alternative Financing Solution
Fortunately, an alternative financing solution – asset-based lending, or ABL for short – can help businesses like these get much-needed cash to finance working capital and meet other short-term financing needs. An asset-based loan is secured by hard assets, such as equipment, machinery, inventory, and accounts receivable.
While ABL is often considered to be a transitional source of financing to carry a business over until it qualifies for a traditional bank loan, some businesses rely on ABL as a permanent source of financing. These including the trucking, apparel manufacturing, import/export, and staffing industries.
Businesses with strong accounts receivable and a solid base of creditworthy customers are often good candidates for an asset-based loan. This is because unlike traditional bankers, asset-based lenders focus mainly on the assets that are pledged as collateral, rather than a business’s projected cash flow.
For example, asset-based lenders usually have machinery and equipment independently appraised before lending money based on them as collateral. If inventory is pledged as collateral, lenders usually want to see regular reports on inventory levels and liquidation values of finished and raw inventory. And if accounts receivable will be pledged as collateral, lenders will analyze the eligibility of the receivables as collateral based on the quality of the debtor base and past-due payment history.
Types of Asset-Based Loans
Asset-based lending is an umbrella term that describes several types of loans secured by business assets. The two main types of an asset-based loan are factoring and accounts receivable financing, or AR financing for short.
With factoring, a lender (usually referred to as a factor) purchases a company’s outstanding accounts receivable. This relieves the business of responsibility for collecting receivables — once the factor buys them, the factor assumes collection responsibility. The business receives from 70 to 90 percent of the value of the receivables right away and the remaining balance, less a fee charged by the factor, when the receivable is collected. Factoring fees are usually between 1.5 percent and 3.0 percent of the amount of money borrowed.
Aside from boosting cash flow, one of the biggest benefits of factoring is that businesses are relieved of the burden of receivables collections. The factor handles such tasks as performing credit checks, analyzing the creditworthiness of account debtors, mailing out invoices and posting payments. This frees up the business’s financial and accounting personnel to perform other more value-added tasks.
With AR financing, the lender will establish a borrowing base at each draw and charge a collateral management fee against outstanding amounts. Receivables that are more than 90 days old usually aren’t counted toward the borrowing base. Interest is charged on the amount of funds the business borrows, which is similar to a bank revolving line of credit.
ABL Demand Remains Strong
Statistics indicate that asset-based loan demand remains strong among mid-sized businesses. According to the most recent Asset-Based Lending Index1, which is published quarterly by the Commercial Finance Association, lending commitments from large and mid-sized asset-based lenders were up 4.1 percent year-over-year at the end of the third quarter of 2018, while outstanding funded loan balances were up 8.4 percent during this time.
It’s important to point out that asset-based lending isn’t the right financing solution for every situation. One of the biggest drawbacks is cost — an asset-based loan tends to be more expensive than traditional bank loans, which is why they are often viewed as a transitional source of financing.
However, for businesses struggling with cash flow issues due to long payment terms dictated by their customers, or businesses that can’t obtain a bank loan or line of credit due to high leverage or temporary financial difficulties, ABL could be just what’s needed to weather a financial storm.
Despite the improving economy and credit environment, there are many mid-sized firms that still have a hard time qualifying for traditional bank loans. Fortunately, an asset-based loan is an alternative financing solution that can help businesses get much-needed cash. With asset-based lending, loans are secured by hard assets, such as equipment, machinery, inventory, and accounts receivable. Businesses with strong accounts receivable and a solid base of creditworthy customers are often good candidates for ABL. A project CFO can be engaged as needed to help you determine if an asset-based loan is the right financing solution.
1 Quarterly Asset-Based Lending Index for 2018 Q3; Commercial Finance Association; CFA.com
Arthur F. Rothberg, Managing Director, CFO Edge, LLC