Your borrowing capacity for an asset-based loan rests on what your assets will support and the maximum line a lender will grant you. Barnett says most asset-based lenders will lend 80 percent of "eligible" receivables and 50 percent of "eligible" inventory. So what do we mean by eligible?
Basically, just because you have an asset on the books doesn't necessarily mean a lender will advance you funds against it. "Asset-based lenders deduct ineligible receivables such as those from mom-and-pop shops, those from customers who have had a bad debt on prior receivables, ones that are more than 90 days old or, perhaps, receivables due from customers overseas," says Barnett.
So on the receivables side, the equation looks like this:
The same concept applies to inventory. That is, the inventory on hand needs to be adjusted by the lender. Specifically, ineligible components must be removed to estimate the eligible portion. Ineligible inventory might include items that are obsolete, certain exotic goods that would be difficult to liquidate, perishables that may spoil before they can be liquidated or materials that are damaged. The inventory equation is as follows:
Barnett says adding the two sums together and subtracting any outstanding debt gives you the amount you can borrow, as long as it doesn't exceed the total line available to your company, which is spelled out in your agreement with the lender.
Why does inventory get such a low advance rate, just 50 percent of eligible inventory, while accounts receivable gets 80 percent of the eligible amount? According to Timothy Gannon, senior vice president of the asset-based group at Sterling National Bank, a publicly held New York City bank that specializes in small- and middle-market companies, "Accounts receivable are self-liquidating, while inventory is not. If a lender needs to liquidate to recover the loan, it will have to take possession of the inventory and sell it, which can be difficult, time consuming and expensive." By contrast, he says, the majority of a company's accounts receivable will, over time (hopefully in 30 days), turn themselves into cash through payments from customers.