What's It Worth?

A Framework For Lending

While lenders making term loans (loans that are paid back over a span of two to five years) certainly consider the value of these assets, value is only a secondary consideration. For the most part, when a banker makes a term loan, he or she is looking at the cash flow of the enterprise and trying to determine whether it is sufficient to service the debt and whether it can be sustained for the term of the loan.

Asset-based lenders, on the other hand, have a dual focus. They, too, look at cash flow, but they also look at two asset classes--accounts receivable and inventory--in terms of their ability to be liquidated to pay off the loan if the cash flow goes south. Short-term asset-based loans generally get paid off as accounts receivable and inventory liquidate.

In growing businesses, however, more accounts receivable and inventory are being generated all the time. As a result of this cycle, an asset-based loan has a revolving quality to it. This can be a good thing because it gives a company time to catch its breath. But it can also work to a company's disadvantage. If an asset-based loan isn't renewed by the lender, for example, the company may be forced to pay the borrowed money back before it's prepared to do so.

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This article was originally published in the March 1999 print edition of Entrepreneur with the headline: What's It Worth?.

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