Accounts receivable and inventory
financing allows borrowers to use
the value of their receivables and inventory as collateral to secure financing.
The financing is then repaid through the
normal course of business.
“It is a financing method that allows a
company to use their current assets to fund
growth,” explains Rick Arcaro, vice president of middle market lending at Comerica
Bank.
Smart Business spoke with Arcaro about
accounts receivable and inventory financing, how companies can benefit from this
type of financing and what factors banks
consider when evaluating potential banking relationships.
What are the basic principles of accounts
receivable and inventory financing?
Basically, it is a financing method where
banks loan money against a company’s
accounts receivable and inventory. The
advance rates are determined by the risk
associated with each asset. Typically,
advance rates are higher with accounts
receivables than inventory because it’s easier to convert a receivable to cash versus
liquidating inventory. Eligible accounts and
inventory will vary depending on the bank,
but typically accounts receivables more
than 90 days from an invoice date or concentrated receivables may be discounted
or considered ineligible. Concentrated
receivables mean that a single customer
has a large percentage, or high concentration, of the overall receivables for the company.
How can a company benefit from this type of
arrangement?
A company can take advantage of trade
discounts by paying suppliers sooner and
receiving a discount. For instance, some
vendors grant a 3 percent discount if they
are paid within 10 days. If you have an
account receivable and inventory line you
can take advantage of these savings. In other words, you can pay your vendors
before cash is collected from a transaction.
The primary benefit of this type of financing is being able to grow your business by
using your assets without having to put
additional capital into your company or
waiting for collections to arrive.
Companies that have strong cash flow
are less likely to need this type of financing
because they have enough cash to fund
operations. Predominately, accounts
receivable and inventory financing is for
companies that are outgrowing their current cash flow. It is also helpful for companies that hold high levels of inventory.
How does a bank assess a borrower’s financial position?
We require financial statements from a
CPA, receivable agings, accounts payable
agings and inventory reports. Some banks
will be more comfortable with a company
that has strong cash flow. Some financial
institutions are more comfortable with
strong collateral. For instance, a finance
company will lend to a company losing money as long as it has good collateral that
can be strictly monitored. On the other
hand, a bank will likely want a profitable
company that also has good collateral.
Each bank may look at each company differently. Generally debt to equity and the
turnover of the assets, or how fast the
asset becomes cash are key factors.
What other factors are considered?
Other factors we consider are similar to
those of any new banking relationship: Are
we comfortable with the company’s management? Are we confident it can execute
its plan? Does it have a good business
model? How does the company stack up
within its own industry?
What types of receivables are ineligible?
Generally, receivables that are 90 days
past the invoice date are normally ineligible. Also, a portion of a concentrated
receivable may be deemed ineligible. For
example, if you are selling to a large retailer and they account for 40 percent of your
total receivables, many banks will not give
credit for any amount over 30 percent — 10
percent would be ineligible.
While these factors may cause an
accounts receivable to be ineligible, there
are strategies that can create eligibility for
these types of accounts. It is possible to
buy credit insurance that guarantees the
receivable will be paid. Foreign accounts
receivables are also typically ineligible.
However, by having foreign credit insurance in place for these receivables, they
could also be considered an eligible receivable. Credit insurance is key with questionable accounts receivables. Overall A/R and
inventory financing can be a significant
tool to help grow your company.
RICK ARCARO is vice president of middle market lending
at Comerica Bank. Reach him at (213) 486-6239 or
[email protected].
