How does a borrowing base work?

Definition

A borrowing base is the eligible pool of receivables and inventory a lender will advance against. On the books, this is a cap on how much you may draw, not the loan balance itself.

You compute it so the lender can see how much collateral still supports new draws. The drawn amount lives on the Balance Sheet; this pool is the math behind the limit.

This pool is not a general-ledger account. It is a formula sitting on top of balances you already carry.

Where it shows up

Balance Sheet: Related to the receivables and inventory the lender will advance against.

P&L: Related to interest on the line this base supports.

Cash flow: Increases in the line, reported cash from financing activities increases.

See also: Borrowing Base Certificate · Line Of Credit · Accounts Receivable Aging

When you look at your Balance Sheet, you will not find this pool as a line. You will find the receivables and the inventory, and you will find the Line Of Credit that this cap is allowed to support.

When the pool is high, more invoices and stock still qualify, so more of the line is usually open. When the pool is low, invoices have aged out, stock has been sold, or ineligibles have grown, and availability shrinks.

The profit and loss statement does not list this pool. Interest on the amount actually drawn hits the Income Statement; the unused room under the cap does not.

On the Statement of Cash Flows, a draw against the line is a financing inflow. This pool did not move cash by itself; the draw did.

A Borrowing Base Certificate is the report that proves the eligible numbers to the lender. Accounts Receivable Aging is the listing that shows which accounts receivable still count.

How it works

The cap starts with the receivable and inventory balances after the close. The lender then subtracts ineligibles, such as invoices past a set age, affiliate invoices, or stock the bank will not fund.

What remains is eligible collateral. Advance rates then cut that remainder, often a high percentage of eligible receivables and a lower percentage of eligible inventory.

• Start with receivables and inventory totals
• Remove ineligibles the agreement names
• Multiply what remains by the advance rates
• Treat the sum as the eligible cap
• Compare the drawn line to that cap for availability

Those two products are added, and any reserve the agreement calls for is subtracted. The result is this pool: the most the lender will let you have outstanding against those assets.

Stay with this pool: it is the ceiling, not the owe. The line still holds only what you have drawn, and interest still follows that drawn amount.

Availability is this pool minus the amount already drawn. If the pool falls below what is outstanding, the shop is overadvanced and may have to repay the excess.

The cap is recomputed each time the certificate is due, often weekly or monthly. A large collection, a slow-paying customer, or a drop in stock can cut availability before the next draw.

A Covenant can require that the certificate be on time and that you stay inside this cap. Missing the cap is a borrowing problem even when the line's approved limit is higher.

Reconcile the formula to the same receivable and inventory totals you issued. A cap built from a draft aging that later changed is how shops think they have room when the lender says they do not.

Example

A wholesale grocer has $200,000 of receivables and $100,000 of inventory. After ineligibles, $180,000 of receivables and $80,000 of inventory still qualify.

The agreement advances 80 percent of eligible receivables and 50 percent of eligible inventory. That is $144,000 plus $40,000, so this pool is $184,000.

The grocer has already drawn $120,000 on the line. Availability is $64,000, which is the room still under the cap.

The grocer then draws $20,000 to pay produce vendors. That draw is the journal; the cap itself does not post.

The grocer records:

Debit: Cash $20,000

Credit: Line of credit $20,000

Cash goes up by $20,000, and the line goes up by $20,000. The Income Statement does not show a $20,000 expense, and this pool is now supporting $140,000 outstanding.

Common mix-ups

A borrowing base is not the loan. The Line Of Credit is the amount drawn; this pool is only how large that draw is allowed to be.

This pool is not the Borrowing Base Certificate. The certificate is the report that proves the eligible numbers; this pool is the result of the formula.

This pool is not gross receivables plus inventory. Ineligibles come out first, and advance rates then cut what is left, which is why the cap is smaller than the asset totals.

Related terms

• Borrowing Base Certificate: The periodic report submitted to a lender proving eligible collateral.
• Line Of Credit: A revolving loan the business can draw on and repay as cash needs change.
• Accounts Receivable Aging: A report bucketing open invoices by how long they have been outstanding.
• Inventory: Goods held for sale or used to produce goods for sale.
• Asset-Based Lending: Borrowing secured by receivables, inventory, or equipment rather than general credit.
• Accounts Receivable: Money customers owe the business for goods or services already delivered.
• Covenant: A condition in a loan agreement the borrower must keep meeting.
• Liquidity: How readily the business can cover near-term obligations with available cash.