Article by Roger Schlueter, MBA
Banks will do Accounts Receivable and Inventory financing but these are done a little differently than the regular business loan. Banks look at Accounts Receivable and Inventory financing as being much more Risky than Real Estate or Equipment Loans. Risk is dependent on several factors that I will discuss with each asset.
Accounts Receivable are considered a better risk when they come from a solid and respected company that has been around forever like IBM or Proctor & Gamble. The Receivables are valued pretty much from the company that they come from, on a scale of IBM to Joe’s Barber Shop. The industry of the company that the Receivables come from is also a risk factor. The industry could be a risky industry at all times like a restaurant or a declining industry like a Letter Mail service. They are also less risky when they are as current as possible. The receivable that is within 30 days is valued much higher that a receivable that is 90 days old or God Forbid!, an over 90 day receivable.
Inventory is considered less risky when the inventory is something that has salable value as it sits. This is something like Raw Metal, or other component of the manufacturing process that can be used by other companies in their manufacturing process. Goods purchased for resale have probably the highest resale value because there is no change in the product itself. The lowest resale in inventory, is inventory that is in the process of being changed and thus limiting the use of this product by other companies.
Accounts Receivable are financed using a formula. This formula is based on the age of the Accounts Receivable and related to its collectability by the bank in case of default. Accounts Receivable are listed as to their age. The standard listing of Accounts Receivable is 30, 60, and 90 days. The account can be up to 90 days old and be used in the formula but usually everything over 90 days is excluded from financing (I say usually because if the bank feels that the company will pay this receivable then that receivable could be counted). Our basis for financing the Accounts Receivable is All Accounts Receivable up to 90 days old. This is the base amount that is Eligible for financing. The Bank will finance a percentage of Eligible Receivables. This percentage is up the Bank to decide but it is usually approximately 70 to 80 percent of Eligible Receivables. The bank will usually finance up to 80% of your company’s Eligible Receivables. Banks sometimes worry about the Borrower Paying Down the Loan as the Receivables are paid back to the Borrower. They can demand a Lock Box or some variation of the Lock Box. This is where the Receivables are paid to the Bank and the Bank Pays Down the Loan. Obviously this is Not Wanted by the Borrower.
Example:
Total Receivables is $100,000 and $50,000 are within 30 days, $20,000 are within 60 days, and $10,000 are within 90 days. The remaining $20,000 in account receivables are over 90 days and thus are not Eligible for financing. ELIGIBLE ACCOUNTS RECEIVABLE ARE $80,000.
The Bank has decided above all other risks like industry and companies owed, that it will finance up to 80% of Eligible Accounts Receivable for your company. The bank will finance 80% of $80,000 which is $64,000.
The Formula is: $100,000 (Total Acct Rec) – $20,000 (Acct Rec over 90 days) = $80,000 of Eligible Receivables.
Bank Financing is 80% of Eligible Acct Receivables or 80% of $80,000 or $80,000 x 0.80 = $64,000
The Bank will finance $64,000 of Accounts Receivable but only if the Eligible Accounts Receivable Stay at $80,000. The Bank will ask for a Monthly Aging of Accounts Receivable and adjust their total amount of financing accordingly. If the Eligible Amount falls then the financing amount will also fall and you will have to pay the loan down to the new level. Looking at the opposite – if the amount of Eligible Account Receivables goes up then the amount of financing should also go up unless there is a Cap on The Total Amount of Financing.
Inventory is a little more straight forward. The Bank will usually finance a percentage of Inventory. This percentage will depend upon the Quality of the Inventory as discussed previously. The percentage will be approximately 50 percent. The percentage can be higher or lower depending on the Banks perceived Risk of financing this type of Inventory.
Example:
Total Inventory is $200,000. The Bank will finance 50% of Inventory or $200,000 x 0.50 = $100,000.
The Bank will also ask for a monthly Listing of Inventory and adjust the amount of financing according to the amounts of inventory that is Reported on the Listing. This amount of financing can be increased or decreased depending on the amount of Inventory Reported Monthly.
The In
terest Rate for Accounts Receivable or Inventory Financing will always be on a variable basis. That is the Interest Rate will be a certain percent above the Base Rate. The Base Rate is usually the Prime Rate but can be tied to other indexes. The final rate will be the base rate plus an additional amount of interest and vary with the up or down of the base rates movements. Prime rate (base rate) is 3.25% and the Spread or additional amount added to the base rate is 3% then the Rate is 6.25% and the rate will usually vary with the movements of the base rate and will be adjusted at every Adjustment Period. The Adjustment Period can be daily, monthly, quarterly or yearly, dependent upon the bank and the banks perceived risk.
terest Rate for Accounts Receivable or Inventory Financing will always be on a variable basis. That is the Interest Rate will be a certain percent above the Base Rate. The Base Rate is usually the Prime Rate but can be tied to other indexes. The final rate will be the base rate plus an additional amount of interest and vary with the up or down of the base rates movements. Prime rate (base rate) is 3.25% and the Spread or additional amount added to the base rate is 3% then the Rate is 6.25% and the rate will usually vary with the movements of the base rate and will be adjusted at every Adjustment Period. The Adjustment Period can be daily, monthly, quarterly or yearly, dependent upon the bank and the banks perceived risk.
Financing Accounts Receivable or Inventory is accomplished everyday by banks and finance companies. The main thing to remember is that the amount can vary according to the amount of Eligible Accounts Receivable or the Amount of Inventory. These Loans are financed like a Line of Credit and usually can be drawn up on or paid down as monies are available by the company. Your security is usually the Account Receivable or Inventory but the bank can ask for and get additional security or collateral if the bank feels the additional Collateral is necessary to cover the Risk they hold while providing the financing.
Please see my website for contact and additional information at www.schlueterfinancial.com or Email me at roger@rogerschlueter.com