If your company has receivables or inventory, chances are you’ve come across somebody who wants to lend you money against them. This loan type, called Asset Based Lending (ABL) is popular. It comes with a catch – especially if your company is not yet profitable. That catch is called a lockbox, and it can cause you real problems with your company’s cash flow if not carefully managed.
What is Asset Based Lending?
ABL uses your company’s accounts receivable and inventory as collateral for a loan. Typically a company could borrow up to 75% – 85% of eligible accounts receivable and up to 40% of eligible inventory. Note the use of the word “eligible.” Banks will only lend against good collateral and will rule out any old receivables over 90 days, those they deem from a risky customer, or obsolete inventory. Know the true worth of your collateral before taking out one of these loans – you may not be able to borrow as much as you hope.
How It Works
When you borrow against your collateral, you have to certify to the bank the value of that collateral. That certification comes in the form of a Borrowing Base Certificate, or BBC. This is a detailed listing of your collateral’s value at the time you make your loan. You won’t be expected to just provide a listing. Many times banks want to know the changes in collateral over time. That means in addition to your outstanding accounts receivable, you’ll be providing information about collections from the last time you certified your collateral. Same goes for inventory. If you don’t want to spend many hours preparing a BBC every time you need cash,then make sure you have good systems in place to manage your changes to accounts receivable and inventory.
How a Lockbox Confiscates Cash
Banks are fundamentally risk averse, and they have many tools available to them to get paid: personal guarantees, limits on collateral availability and requirements to maintain cash accounts at the lender. Expect all this with an ABL and one more requirement: a lockbox. This lockbox accumulates all cash that your company collects and deposits it into a special account. At the end of the day, the lockbox “sweeps” all your company collections into the bank’s loan account. Effectively, you are paying off their loan to you every time your company receives a check.
Effectively, your company’s cash balance is $0.00 until you drawdown against the loan. When you need cash for paying employees or vendors, you complete a BBC and the bank wires you the money. Here’s the catch – the bank will only lend to you up to the value of eligible collateral and only if the BBC is properly prepared. If the value of your collateral deteriorates (and usually the bank has sole discretion on eligible collateral) or you make mistakes with your BBC, you could very quickly find yourself short of cash.
What You Can Do to Manage A Lockbox
There are things you can do to better manage a lockbox:
Ask the bank to maintain the loan balance and not sweep funds into the loan account
You’ll always have a loan balance outstanding that you can pay down whenever you have excess cash. While you will pay more in interest costs, you’ll also have your regular cash flow available to you. You will save a lot of administrative time preparing BBCs. You’ll only be submitting BBCs at the end of the month which are easier to do when you close the end of the month. Any shortages of collateral will need to be handled at this time.This tends to work better at banks where you have a banking relationship. If they can see healthy cash balances in your banking accounts they may be more amenable to this kind of arrangement. You have to negotiate it when you are negotiating your deal – if you wait until afterwards it may be too late. If you don’t have a deposit relationship then this gets much harder to do.
Prepare a rolling 12-week cash flow forecast
Know your cash needs – and anticipated collateral availability – in advance of your drawdown request. Base it around your payroll since that is most company’s largest recurring expense. You want to time your drawdowns before you need the cash, and you want to borrow as much as you can to cover any unexpected items. Don’t try to save a few dollars on interest costs by cutting it too close.
Create systems to readily prepare a BBC
Have solid accounts receivable, cash and inventory management systems in place where you can run reports that populate the BBC. Your company should have these anyway. If your receivables or inventory are aging then that is a sign of a problem that needs to be investigated. Ask the bank to provide you a sample BBC before the loan closes so you can see exactly what is required, and how long it will take to prepare a compliant response.