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Now It's Time to Get a New Look at Asset Based Lending, including Trucking Factoring
There are many misunderstandings amongst CFOs and finance executives when it pertains to asset-based lending. The biggest is that asset-based lending is a financing option of last hope - one that only " hopeless" companies that can't get a traditional bank loan or line of credit would think of.
With the economic downturn and resulting credit crunch of the past few years, though, many trucking companies that might have secured more traditional kinds of bank financing previously have as an alternative turned to asset-based lending. And to their surprise, many have discovered asset-based lending to be a versatile and cost-effective financing tool.
What Asset-Based Lending Looks Like
A normal asset-based lending scenario frequently looks something similar to this: A business has stayed alive the recession and financial crisis by aggressively managing receivables and inventory and postponing replacement capital expenditures. Now that the economy is in recovery (albeit a weak one), it will need to build up working capital to fund new receivables and inventory and fill new orders.
Unfortunately, the business no longer qualifies for traditional bank loans or lines of credit due to high leverage, weakening collateral and/or an excessive amount of losses. From the bank's point of view, the business is no longer creditworthy.
Even trucking businesses with strong bank relationships can run afoul of loan covenants if they go through short-term losses, in some cases requiring banks to pull the plug on credit lines or decline credit line increases. A couple of bad quarters doesn't necessarily suggest that a truck business finds themselves in difficulty, but often bankers' hands are tied and they're required to make financing decisions they might not have a few years ago, before the credit crunch altered the rules.
In instances like this, asset-based lending (trucking factoring companies) can supply the needed finances to really help freight businesses weather the storm. Companies with solid accounts receivable and a strong base of creditworthy customers tend to be the very best candidates for accounts receivable financing loans.
With conventional bank loans, the banker is predominantly worried about the borrower's projected cash flow, which will provide the funds to repay the loan. As a result, bankers pay especially close attention to the borrower's balance sheet and income statement so as to evaluate future cash flow. Asset-based lenders, alternatively, are primarily worried about the performance of the assets being pledged as collateral, be they machinery, inventory or accounts receivable.
So before lending, asset-based lenders (trucking factoring companies) will normally have machinery or equipment independently valued by an appraiser. For inventory-backed loans, they normally require regular reports on inventory levels, together with liquidation valuations of the raw and finished inventory. And for loans backed by accounts receivable, they often perform detailed analyses of the eligibility of the collateral based on past due, concentrations and quality of the debtor base. But unlike banks, they often do not place tenuous financial covenants on loans (e.g., a maximum debt-to-EBITDA ratio).
Asset-Based Lending(freight factoring companies): The Nuts and Bolts
Asset-based lending is actually an umbrella term that encompasses several different varieties of loans that are secured by the assets of the borrower. The two primary types of asset-based loans are factoring and accounts receivable (A/R) financing.
Factoring is the outright purchase of a business' outstanding accounts receivable by a commercial finance company (or factor). Normally, the factoring company will advance the business between 70 and 90 percent of the value of the receivable at the moment of purchase; the balance, less the factoring fee, is released when the invoice is collected. The factoring company fee typically ranges from 1.5-3 .0 percent, depending on such factors as the collection risk and the amount of days the funds are in use.
Under a contract, the trucking business can usually pick which invoices to sell to the factoring company. Once it purchases an invoice, the invoice factoring company deals with the receivable until it is paid. The invoice factoring company will practically become the business' defacto credit manager and A/R department, " completing credit checks, analyzing credit reports, and mailing and documenting invoices and payments.".
A/R financing, on the other hand, is more like a typical bank loan, with some chief differences. Although bank loans may be secured by different kinds of collateral including equipment, real estate and/or the personal assets of the business owner, A/R financing is backed strictly by a pledge of the business' outstanding accounts receivable.
Under an A/R financing arrangement, a borrowing base is set up at each draw, against which the business can borrow. A collateral management fee is charged against the outstanding amount, and when funds are advanced, interest is assessed only on the amount of money actually borrowed.
An invoice generally must be less than 90 days old in order to count toward the borrowing base. There are often other eligibility covenants like cross-aged, concentration limits on any one customer, and government or international customers, depending on the lender. In many cases, the underlying business (i.e., the end customer) must be viewed as creditworthy by the finance company if this customer constitutes a majority of the collateral