Lending Based on Today’s Assets, Not Tomorrow’s Forecasts

Although the business climate is in a different place today than it was in 2020, companies still face a wealth of challenges impacting performance. Businesses have had to adapt, pivot, adjust, upsize and downsize to survive. Today, many are evaluating balance sheets and cash flow statements that look radically different than they did a few years ago, leaving owners and managers wondering how best to obtain the financing they need to grow and thrive.

When COVID-19 hit, no one anticipated the continuing chain of events businesses would experience. Among them was the fact that many businesses were able to accumulate inventory – often excess inventory – to counteract anticipated supply chain issues. Government stimulus incentives that businesses received early in the pandemic allowed them to retain staff and fund ongoing operations until sales returned to somewhat-normal levels.

In the meantime, supply-chain issues have continued, inflation has surged and companies are operating with an uncertain economic future. They still need financing, but the standard route of using a traditional bank for a loan has become less certain. It’s much harder to forecast, much harder to present those uncertain forecasts to banks, and as a result, much more challenging to obtain a low-interest rate loan. With concerns about heading into a recession, we expect banks to tighten lending criteria further.

Focus on assets versus cash flow

Just as businesses shifted and changed operations over the past few years, it may now be time for a shift in financing options. Whereas banks continue to evaluate prospective borrowers on the basis of cash flow, with focus on future performance, businesses with inventory and receivables are looking for evaluation of assets and a focus on what they have now.

Shifting that evaluation priority is where asset-based lending (ABL) comes in. In contrast to the bank loan process, ABL looks first at assets and then at cash flow. Underwriting and credit structure are flexible. By zeroing in on a company’s assets – and generally inventory and receivables, those that turn into cash fastest – an asset-based lender can assign more value to them, and as a result, lend more.

Many businesses can obtain asset-based loans for a higher dollar amount than they could with a traditional cash-flow loan from a bank – additional capital needed to navigate and grow in an uncertain economy. A good asset-based lender will take the time to understand a business, and analyze its risks, strengths and weaknesses. They’ll evaluate the real value in each asset class and maximize the amount they can loan to each asset group.

For example, a company may end up getting financing based on 90% of its receivables, 80% on equipment and 50% on inventory. Depending on the company, the net could be 85-90% across the board. If that same company could obtain a bank loan, it may be at a lower interest rate – but for a lower amount. The availability of ABL for companies that need cash to turn into sales and profit is significant.

What we’re seeing in the market

With the likelihood of banks tightening lending requirements in early 2023, we’ve started to see substantial interest from companies sitting on large inventory and high receivables. We’re hearing from finance officers, accountants and financial advisors of companies poised for growth, seeking capital to fuel their business. They need more than a bank can offer, and they are looking for an option that will give them credit for the value of their assets, and ability to fund their immediate sales.

ABL isn’t for everyone, but the variety of companies and industries turning to it in the current economic environment is telling. Our current ABL clients have sales of $2 million to $2 billion, with lines of credit from $1 million to $15 million and beyond. The range of use cases is broad. Here, consider just a few.

• Increase in sales. A large staffing company upped sales by more than $5 million with ABL. We were able to more than double the company’s borrowing capability – from $1 million it could get with a bank loan to $2.5 million with ABL. That capital infusion converted to an additional $5 million in sales.
• Bridging a cash flow gap. A current client and distributor of auto parts requested a temporary increase in overall credit limit because they were experiencing difficulties due to chip shortages, an unexpected drop in accounts receivable, and supply chain issues that impacted lead time to secure products. Instead of inventory receipt in 45-65 days, the timeframe extended to 90-150 days. With the delays, they faced cash-flow shortages due to the buildup of excess inventory. After reviewing the client's history with us, as well as recent field exams, we provided a temporary increase to their line of credit. By stretching on inventory advances and being flexible on terms, we could help the client immediately address short-term needs.
• New jobs. An industrial manufacturer financed the cost of launching projects that generated a substantial number of jobs, and renovated a large facility with ABL funds. When traditional lenders said “no,” we used the company’s accounts receivables and inventory as collateral to help them realize this opportunity.

Just as the world looks different than it did in early 2020, companies looking for financing today are looking at a very different lending environment. Lingering supply chain issues, persistent inflation and concerns about a recession can make it difficult or impossible to create accurate forecasts. For companies with solid assets and significant growth potential, ABL can be a smart financial move in an uncertain economy.