Mining the Balance Sheet for Working Capital

Let’s face it… There has been significant liquidity in the marketplace over the past couple of years. Debt and equity capital has been relatively easy to find and commercial banks have been very willing participants as capital providers; however, many of the commercial banks have admitted that this robust marketplace is a prolonged cycle and not a permanent or semi-permanent marketplace shift. By definition as a cycle, what goes up must come down.

Asset Based Lending Versus Commercial Bank Cash Flow Lending

Already, many of the commercial banks are starting to whisper about declining portfolio quality and tighter credit standards. This has been attributed to issues regarding the subprime mortgage market, rising energy costs, and other economic factors. These issues have resulted in some companies experiencing a weaker balance sheet and a decline in cash flow results.

As banks start to tighten their credit standards, many companies may find they have less access or no access to working capital from commercial banks. Banks may elect not to renew certain loans that come due. Also, companies that have tripped a covenant or are in a technical default may find that their commercial bank is not as patient and will ask to refinance that loan.

So, how can a company still access adequate working capital in a changing bank marketplace? One way is to go about mining the balance sheet assets through an asset based, working capital line of credit.

Comparison

Asset based lending is more common than ever and has become for many companies a more aggressive way to grow their business. Asset based lenders look beyond a company’s cash flow and balance sheet ratios to leverage the business assets for working capital purposes. They also provide an ease of doing business and typically have less restrictive operating covenants than commercial banks.

Commercial Banks

Commercial banks typically underwrite and grant credit by emphasizing in the following order:

1) Balance Sheet Strength/Cash flow
2) Management/Guarantors
3) Collateral/Assets

Asset Based Lenders

Asset based lenders assume there is some fundamental weakness to #1 above (at least by commercial bank standards) and then flips the above equation upside down. The result is asset based lenders typically underwrite or grant credit by emphasizing in the following order:

1) Collateral/Assets
2) Management/Guarantors
3) Balance sheet strength/Cash flow

By emphasizing the value of a company’s assets as security and collateral for a working capital line of credit, an asset based lender has greater patience and tolerance for the bumps in the road and inconsistencies in the marketplace that many companies will face on a regular basis. Asset based lenders typically will provide a revolving line of credit against accounts receivables and inventory as collateral. Many asset based lenders will also provide term loans against equipment and possibly real estate.

Obviously, asset based lending is not the answer for every company’s need for working capital. It’s because not all companies generate these types of assets. Companies selling at retail or on cash terms don’t typically generate commercial accounts receivable, which is the asset that most asset based lenders leverage as the base for a loan; however, if a company is involved in manufacturing, distribution and many of the service industries, then chances are they would generate the types of assets favored by asset based lenders.

Benefit of Asset Based Lending

The benefit of this type of lending is that the loan availability can grow as a company’s assets grow and, therefore, is not as restrictive as traditional commercial bank cash flow lending – especially in rapid growth situations. Since asset based lenders rely primarily on the company’s collateral versus its cash flow results, they embrace greater credit risk. They also accept inconsistent cash flow results versus commercial banks.

So as the marketplace changes and as commercial banks start to tighten up, remember that accessing adequate working capital may be as simple as mining the balance sheet through asset based lending.

See Also:
Categories of Banks
Working Capital from Real Estate
Originally posted by Jim Wilkinson on July 24, 2013.