by Steven M. Rosenberg ield examinations provide specific and timely facts ➤ Status of the accounts payable and related liabilities to the lender regarding the borrower’s collateral. that affect the borrower’s collateral; The results of the field examination are used by the ➤ Timeliness of the field examination; lender in conjunction with the CPA’s financial ➤ Eyes and ears of the lender; F ➤ statements to help the lender manage its relationship with Liquidation scenario. the borrower. Some asset-based lenders and factors maintain their Analysis of the borrowing base certificate own internal staff of field examiners, while others engage When loans are secured by accounts receivable and outside firms to perform the examinations. The outside inventory, the lender frequently requires the borrower to firms are generally CPA firms, consulting firms or sole complete periodic borrowing base certificates (typically independent contractors. Field examiners are generally monthly). A borrowing base certificate illustrates a accountants, former lenders or CPAs. borrower’s eligible collateral (accounts receivable and Lenders primarily rely on field examinations for the inventory) compared to the existing loan balance. The following reasons: result is either that the collateral is more or less than the ➤ Analysis of the borrowing base certificate; loan balance. The certificate illustrates to the lender if the ➤ Detailed description of the collateral, its eligibility borrower’s loan balance is protected by the borrower’s and its performance; secured working-capital assets. ➤ Description of the bookkeeping procedures related to the collateral and underlying controls; (Continued on page 46) 44 THE SECURED LENDER JULY/AUGUST 2003 VOLUME 59 NUMBER 4 In general, the borrowing base parameters are set up Accounts receivable aging report as of July 31, 2002: $ 100 by the lender at the beginning of the relationship. The main Less: parameters include (1) gross accounts receivable and Accounts receivable greater than inventory balances, (2) amounts that are considered 90 days from invoice date (15) ineligible to lend upon and (3) the advance rates on eligible Eligible accounts receivable 85 collateral. Advance rate 80% Gross accounts receivable is generally based on the Available accounts receivable 68 total accounts receivable aging report at a given date. Gross inventory is generally based on the perpetual inventory Perpetual inventory as of July 31, 2002: 75 report at a given date (usually month-end). Less: Ineligible accounts receivable are typically accounts Slow-moving inventory (10) that would be difficult to collect in a liquidation scenario. Eligible inventory 65 These accounts include, but are not limited to, accounts Advance rate 40% greater than 90 days past due, intercompany and related Available inventory 26 company accounts, foreign accounts receivable not sup- ported by letters of credit, credit insurance or another form Available collateral 94 of payment guarantee and accounts where there is an Loan balance 85 offsetting accounts payable balance with the customer. Availability excess / (shortfall) $ 9 Ineligible inventory are items that would not be readily saleable in a liquidation scenario. These inventory items include, but are not limited to, work-in-process, Detailed description of the collateral, its eligibility and its inventory over one year old and customer-specific type performance packaging. Field examinations focus primarily on the quality and the The advance rate is a percentage that is applied to the performance of the borrower’s accounts receivable and eligible collateral to determine the borrowing limits. inventory. The performance of the collateral has a direct Advance rates should provide the lender with a cushion to effect on the net borrowing availability based on the absorb any unforeseen collateral deficiencies and advance rates and eligible collateral. additional collection costs. In general, advance Accounts receivable: Field examination reports rates range from 60 percent to 90 percent for illustrate the spread of the current accounts receiv- accounts receivable and 10 percent to 50 able aging compared to historical aged balances. percent for commercial, noncommodity- This helps the lender determine the trend of the type inventory. Advances are usually accounts receivable. For example, say the determined or adjusted from informa- over-90 days balance on the accounts tion gathered in the field exam report. receivable aging has increased from To illustrate the borrowing base quarter to quarter for the past year. It calculation, assume at July 31, 2002 would appear that the quality of the that gross accounts receivable is $100 accounts receivable is declining. (with $15 over 90 days) and gross The report also includes the inventory is $75 (with $10 over one- top customer aged balances year old). Advance rates are 80 compared to the total percent for accounts receivable and balance. This enables 40 percent for inventory. The loan the lender to balance was $85. The following determine table illustrates the sample whether borrowing base, which resulted in excess collateral availability of $9: 46 THE SECURED LENDER there is a customer concentration and whether impact on the actual age of the account balance. the customers are creditworthy. Lenders are Accounts receivable agings that are invoice- generally not in favor of significant customer date-based age the invoice from its date of concentrations, especially customers with generation (an invoice that is 35 days old poor credit, since the loss of a single cus- would be in the 30-60 days column). Due- tomer would cause a significant decline of date-based accounts receivable agings age revenue and profits. the invoice based on the date it is due. The field examination report provides Assume that an invoice has 90-day terms. a detailed calculation of accounts receivable turnover and It would be in the current column for the first 90 days and, the average net collection of the accounts receivable (i.e., when it advances to the over 90-day column, it would have accounts receivable collected after credits, returns, deduc- been in excess of 180 days from generation. This is tions and bad debts, also known as dilution). In particular, important information for a lender who considers all the dilution statistic helps the lender determine the advance invoices over 90 days from generation as ineligible, rates. For example, if customer credit memos increased to regardless if they are due or not. an average of ten percent of gross sales (net collections Inventory: Field exams discuss the flow of inventory, being 90 percent) from one percent of sales, then the lender how it is valued in each stage (if manufactured), where it is would be inclined to lower the advance rate on the accounts located, obsolescence policy and reporting capabilities. receivable because the lender expects to collect less of the One of the simplest, but most important, aspects of borrower’s gross accounts receivable should the borrower inventory reporting considers whether the inventory is enter into a liquidation scenario. accounted for using the periodic or perpetual method. Inventory: Field examinations indicate the stage of Borrowers using a periodic method are estimating the inventory (if it is manufactured) and where it is located. inventory based on a count from a prior period (usually Work-in-process or inventory located in a foreign ware- year-end). In a borrowing-base situation, lenders generally house may have significantly less value to a lender than require that the inventory be maintained on a perpetual finished goods located in a domestic warehouse. In the system. This allows the borrower, and subsequently the event that the lender has to liquidate the inventory, it would lender, to determine the inventory value at any date and be much easier to resell finished goods located in a domes- time. tic warehouse. Field examinations also illustrate inventory turnover. Status of the accounts payable and related liabilities that The result of this calculation generally has a direct impact affect the borrower’s collateral on the marketability of the inventory. In general, field Similar to the accounts receivable analysis, the field examiners specifically attempt to determine inventory by examinations illustrate the accounts payable concentrations age and may consider inventory over one-year old as and historical aging comparisons. The concentration ineligible. The assumption is that if the inventory has not illustrates the borrower’s suppliers, the amount due to the been sold in the ordinary course of business within the past suppliers and the age of the payables. Borrowers who are year, it would not be readily marketable at the current value dependent on single suppliers may be cut-off from ship- should it have to be liquidated. ments if they let the accounts payable get too old. The In addition, field examination reports compare the historical aging reports illustrate to the lender how the inventory value by location to its insured value. Uninsured payables are performing and the direction of the trend. inventory may be considered ineligible, since it would have Field exams also determine whether the borrower is no value if destroyed in a fire or another unforeseen event. current on federal payroll taxes. One of the few liabilities that can become senior to secured collateral debt is unpaid Description of the bookkeeping procedures related to the federal payroll taxes. collateral and underlying