Closer scrutiny Featured

8:00pm EDT March 26, 2009

If your loan covenants specify that your lender has the right to verify assets and you have not yet been subject to a field audit, you could receive a call any day now. If you’re applying for new credit, be advised that many lenders are now requiring quarterly, semiannual or annual asset verifications.

“In light of the current recession and resulting restrictions on credit, lenders have become increasingly prudent in their lending decisions,” says R. Austin Marks, CPA, CFF, CFE, CFFA, senior associate at Cendrowski Corporate Advisors LLC. "There will be extra diligence on the front end and stricter terms throughout agreements, including more asset verification and increased transparency. Many businesses are facing the prospect of bankruptcy; without liquidity supplied by lenders, these businesses might become insolvent. The risk that borrowers might overstate their assets in order to stay afloat is one of the primary reasons why lenders are increasingly requiring asset verifications.”

Smart Business asked Marks how companies can better understand what it means to be subject to asset verification.

Please provide a general overview of theasset verification process.

Asset verification is the process for whichan asset-based lender, whether it is a bank, a finance company, etc., verifies a creditor’s reported assets. Asset verifications are typically defined in the terms of the loan. The lender is basically attempting to ensure compliance with various loan covenants and adequacy of collateral coverage of outstanding loans. Generally, the lender will send field auditors to the creditor’s facility and perform various procedures to verify the assets collateralizing the loan. The results of the asset verification can have a wide range of implications from changing the credit terms to calling the loan.

What can a company expect during a sitevisit?

Professional skepticism is one of the first rules of thumb for field auditors on asset verifications. Well-trained field auditors areaware of the potential vulnerable areas for misstatement and will look closely at those facets of the business. In general, field auditors are quite diligent and thorough in rooting out anomalies; if they pose questions that your management or personnel cannot answer or that you can only answer after along delay, there will most likely be follow up in those areas, with closer scrutiny. To the extent allowed in the loan agreement, field auditors often will arrive with as little notice as possible to prevent creditors from having time to ‘prepare’ for the asset verification. Field auditors also will be cautious not to over rely on information provided by software programs. If incorrect information is input into the software, incorrect results willbe reported. In determining balances or amounts, they will follow the flow of information to ensure the backup information supports the reported balances.

What more will lenders be requiring of creditors moving forward?

Many lenders will be working to ensure that there are no limits to their ‘right to audit’ clause. They do not want to be limited in their scope, their frequency, how much notice they need to give, etc. They also want to ensure that field auditors have complete access to creditors’ information as they see fit. Loan terms would spell out all of these lender rights to avoid problems down the road.

Does the lender have the right to request any type of real-time monitoring of the creditor’sactivities?

Some lenders may require as part of the loan agreement that the creditor allow an Open Database Connection (ODBC) interface between the lender and the creditor’s Enterprise Resource Planning (ERP) system. This would allow the lender real-time monitoring of the creditor’s transactions inorder to determine compliance. An ODBC interface can integrate an automated monitoring capability into the creditor’s system by providing real-time access to critical performance measures and indicators.

What steps can creditors take to ensure successful audits?

Having a sound system of internal control will help the creditor produce more reliable financial information. If you have poor internal controls, you will likely have unreliable reporting mechanisms, and thus unreliable (reported) results. If you know your information is reliable, there shouldn’t be any surprises during the audit. On the other hand, if your reporting is unreliable, the auditor might determine an entirely different value from transactions based on his or her own testing. Sound internal controls also help protect you from fraud and protect you from getting hit three ways. First, if fraud is occurring, you lose the value of what has been stolen. Second, if your borrowing level is based on a percentage of accounts receivables that never really existed, you may be over advanced and subject to the lender’s make-whole requirements. Third, if your lender determines through asset verification that it lent you money based on assets that were never really there, you may end up incurring higher-than-anticipated borrowing levels and consequently additional interest expense.

R. AUSTIN MARKS, CPA, CFF, CFE, CFFA, is a senior associate at Cendrowski Corporate Advisors LLC. Reach him at (866) 717-1607 or cs@cendsel.com or visit the company’s Web site at www.cca-advisors.com.