Borrowing base definition
/What is a Borrowing Base?
The borrowing base is the total amount of collateral against which a lender will lend funds to a business. It presents a maximum cap on how much asset-based debt a business can obtain. This typically involves multiplying a discount factor by each type of asset used as collateral. For example, 60% to 80% of accounts receivable less than 90 days old may be accepted as a borrowing base, while only 50% of finished goods inventory may be accepted as a borrowing base. It is also common for a lender to only use the accounts receivable of a borrower as collateral - it may not accept any inventory as part of the borrowing base. In rare cases, a small percentage of the fixed assets may also be allowable as part of the borrowing base.
How to Calculate a Borrowing Base
The steps involved in calculating a borrowing base are as follows:
Identify eligible collateral. The first step is to determine the types of assets that can serve as collateral, such as accounts receivable, inventory, and equipment. Not all assets qualify; for example, old or uncollectible receivables and obsolete inventory may be excluded. Lenders typically focus on liquid and reliable assets that can be converted to cash if needed.
Apply advance rates. Lenders assign advance rates to different types of collateral based on risk. For example, a lender may provide financing for 80% of eligible accounts receivable and 50% of inventory. These rates reflect the lender’s assessment of how easily each asset can be liquidated and its expected value in case of default.
Calculate the borrowing base. The borrowing base is calculated by multiplying the value of each eligible collateral category by its respective advance rate. For example, if a business has $500,000 in eligible receivables with an 80% advance rate and $300,000 in inventory with a 50% advance rate, the borrowing base would be:
(500,000 × 0.80) + (300,000 × 0.50 = 400,000 + 150,000 = 550,000
Adjust for reserves and deductions. Lenders may apply additional deductions to account for risks such as customer disputes, slow-moving inventory, or concentration risks (if too much collateral comes from a single customer). If the lender imposes a $50,000 reserve, the final borrowing base would be $550,000 - $50,000 = $500,000.
Determine the maximum loan amount. The lender will typically offer a loan amount up to the borrowing base, ensuring the business does not borrow beyond its collateral value. If the borrowing base decreases (e.g., due to declining receivables), the business may be required to repay some of the loan or provide additional collateral.
By following these steps, lenders ensure that loans are backed by sufficient collateral, reducing their risk while providing businesses with access to working capital.
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Borrowing Base Certificate
A business that borrows money under a borrowing base arrangement usually fills out a borrowing base certificate at regular intervals, in which it calculates the applicable borrowing base. A company officer signs the certificate and submits it to the lender, which retains it as proof of the available amount of collateral. If the borrowing base stated on the certificate is less than the amount that the company is currently borrowing from the lender, then the company must pay back the difference to the lender at once.
Monitoring of the Borrowing Base
Careful monitoring of the borrowing base is of particular importance in seasonal businesses, since the inventory portion of the base gradually builds prior to the selling season, following by a sharp increase in the receivable asset during the selling season, and then a rapid decline in all assets immediately after the season has been completed. It is necessary to balance loan drawdowns and repayments against these rapid changes in the borrowing base to ensure that the company does not violate its loan agreement.
Borrowing Base in Invoice Financing
When a business enters into an arrangement with a lender to obtain invoice financing, the borrowing base is comprised solely of the invoices that the business has issued to its customers, and against which the lender has agreed to extend a loan. This borrowing base is changing constantly, as invoices are paid by customers and replaced by other invoices. This means that the borrower will need to issue a revised borrowing base certificate to the lender, possibly on a daily basis.
Example of a Borrowing Base
ABC International applies for a line of credit. ABC has $100,000 of accounts receivable and $40,000 of finished goods inventory. The lender allows 70% of the accounts receivable and 50% of the inventory as the relevant borrowing base, which means that ABC can borrow a maximum of $90,000 (calculated as $70,000 of accounts receivable and $20,000 of inventory) against its collateral.