Why a 2 Million Dollar Credit Line May Provide Less Available Cash

A business may have a $2 million asset based credit commitment and still be unable to draw $2 million. Before building a purchasing plan around a facility, management needs to understand how availability is calculated.

Wells Fargo explains that an asset based facility uses collateral values and advance rates to determine borrowing capacity. The OCC also describes eligibility criteria, reserves and monitoring as important features of these facilities. The specific loan agreement controls the calculation.

Separate the commitment from the borrowing base

The commitment is the facility ceiling. The borrowing base is the amount supported by eligible collateral under the agreed formula. Outstanding loans and other applicable deductions then affect additional availability.

A simplified illustration starts with the lower of the commitment and the calculated borrowing base, then subtracts reserves and outstanding loans. Some agreements apply reserves elsewhere in the formula or include additional deductions. Ask the lender to demonstrate the calculation using your own records.

Work through the numbers before making commitments

Assume, solely for illustration, a company has a $2 million commitment. It reports $1.6 million of receivables, but only $1.2 million qualifies. At an assumed 80 percent advance rate, those receivables support $960,000. Assume eligible inventory contributes another $300,000.

The borrowing base is $1.26 million. With $100,000 in reserves and $700,000 already outstanding, additional availability is $460,000 in this simplified example. The remaining $1.3 million below the commitment is not necessarily drawable. These percentages are hypothetical, not a market quote or lender promise.

Ask what happens during your busiest month

Bring a projected receivables and inventory schedule to the financing discussion. Ask the lender to show availability before a large shipment, after invoicing and after collection.

This exercise can reveal a timing mismatch. A purchase may require cash before the related assets qualify for the facility. The business can then discuss a revised purchasing schedule, additional equity or another financing component before placing the order.

Create a simple availability routine

Have one person prepare the collateral report and another review it against the accounting records. Keep a short log of changes in assumptions and ask the lender to explain any adjustment you do not understand.

Before accepting a term sheet, request a written example covering a normal month and a stressed month. Compare the expected usable cash with the forecasted operating need. Lirodean can help evaluate an ABL proposal in the context of your assets and cash cycle. Contact us with your receivables, inventory and existing debt information to begin that review.

Explore the related service: Lirodean Asset Based Lending  |  Contact Lirodean