Asset-based financing is a catch-all term for a type of financing that allows you to finance corporate assets such as receivables, inventory, and equipment. When financing accounts receivable, the asset-based financing solution works a lot like a conventional business line of credit. On the other hand, when you are financing inventory and equipment, the solution operates like a term loan.
In this article, we discuss how asset-based lines of credit work. We also compare the qualification requirements to those of a conventional line of credit.
Who should consider an asset-based line of credit?
Generally, an asset-based financing line of credit can help companies that are low on cash because their funds are tied to slow-paying accounts receivable. This solution can streamline your cash flow and provide funds to operate the business and invest in new opportunities.
Asset-based lines of credit are provided to companies that need a minimum line of $750,000. The line is secured by your accounts receivable, so your company must have sales to creditworthy commercial clients. Aside from that, your accounts receivable must not be encumbered by other financing (e.g., business loan). Otherwise, the existing lender must be willing to subordinate its position on the receivables.
The company must be able to provide reliable and up-to-date financial reports. Lastly, the company should have a well-established receivables collection process.
How does the line of credit work?
The lines are offered under an asset-based lending program and work much like a conventional line of credit. To draw funds, the client submits a borrowing base certificate to the lender. Once they have the certificate, the lender wires funds to your account.
The borrowing base certificate is a streamlined financial report that calculates the amount of eligible receivables that can be financed. The borrowing base certificate is one of the reasons why having up-to-date accounting is an important requirement for this program. Without accurate accounting, you would not be able to create an accurate borrowing base certificate.
Funds are repaid to the asset-based lender through the standard collections process, as your clients pay their invoices. The line operates as a revolving line of credit and can be used as much as needed.
Asset-based financing lines of credit have funding limits. However, the limit is often determined by the value of your business’s accounts receivable. As such, the line increases and decreases as the value of your receivables rises and falls. Once the value of your receivables exceeds the credit limit, you must to speak to your lender to increase your line. However, getting an increase is usually easy, especially if your business is well-run.
Differences with conventional lines of credit
There are some important differences between asset-based financing lines of credit and conventional business lines of credit. Here are the four key areas of difference:
1. Accessing funds
Some commercial lines of credit allow you to simply transfer funds from your line of credit account to your regular bank account. This method is obviously simple and convenient. Asset-based financing lines of credit require that you create a borrowing base certificate.
Most conventional business lines of credit have stringent qualification requirements. The lines are available only to clients with solid financial statements, a good track record of performance, and substantial assets.
Qualifying for an asset-based financing line of credit is easier than qualifying for a business line of credit. The most important requirements to qualify are to have quality accounts receivable and a viable business. Asset-based financing lines of credit can be used by companies that need to improve cash flow, are growing quickly, or are going through a turnaround.
Conventional lines of credit have stringent covenants. Covenants are contractual requirements that your company must comply with in order to keep the line operational. Covenants include keeping a certain net worth, keeping financial ratios at certain levels, undergoing a monthly certification, and advising the lender of material changes. Asset-based lines of credit also have covenants, but they tend to be more flexible and are easier to comply with.
4. Line increases
One area in which asset-based financing lines of credit outperform conventional facilities is the request for a line increase. In most cases, increasing the size of a conventional line of credit requires the lender to perform some substantial underwriting of the facility. Furthermore, lenders tend to increase only those lines that already have a track record of performing.
Most line increases for an asset-based financing line of credit can be approved in a matter of days. The most important requirement is that your company have quality accounts receivables. There are cases, especially when the line reaches a substantial amount, where additional underwriting may be required. This process can usually be completed in about a week.
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