What is a Borrowing Base?
A borrowing base is a formula-driven calculation that determines the maximum amount a business can borrow under an asset-based lending (ABL) facility at any given time. Unlike a traditional term loan with a fixed principal amount, ABL availability fluctuates based on the value of underlying collateral assets.
The borrowing base concept provides lenders with a mechanism to adjust credit exposure as asset values change, offering both flexibility to borrowers and risk mitigation for lenders.
Typical Advance Rate Ranges (Illustrative)
Advance rates represent the percentage of asset value that a lender will include in the borrowing base. These rates vary by lender, industry, and borrower risk profile. The following ranges are illustrative and not prescriptive:
Common Advance Rate Ranges
- Accounts Receivable: Typically 70-90% of eligible receivables
- Inventory: Typically 30-65% of eligible inventory (varies significantly by type and marketability)
- Equipment: Typically 50-80% of orderly liquidation value (OLV) or forced liquidation value (FLV)
Note: These ranges are for illustrative purposes only. Actual advance rates depend on lender-specific criteria, industry dynamics, and individual borrower circumstances.
Eligible vs. Ineligible Assets
Not all assets on a company's balance sheet qualify for inclusion in the borrowing base. Lenders apply eligibility criteria to ensure collateral quality and liquidity. Understanding these concepts is important for businesses evaluating ABL structures.
Accounts Receivable Eligibility Concepts:
Common ineligibility factors include:
- Invoices past due beyond a certain threshold (e.g., 90 days)
- Receivables from affiliates or related parties
- Customer concentration exceeding specified limits
- Foreign receivables without credit insurance
- Disputed invoices or contra accounts
Inventory Eligibility Concepts:
Common ineligibility factors include:
- Obsolete, slow-moving, or damaged inventory
- Work-in-progress (WIP) beyond a certain percentage
- Inventory held on consignment or not owned outright
- Inventory subject to third-party claims or liens
- Inventory stored at unapproved locations
Why Availability Fluctuates
Unlike a term loan where the principal balance decreases over time through amortization, ABL availability moves up and down based on the borrowing base calculation. Several factors drive these fluctuations:
- Seasonal Business Cycles: Inventory builds increase availability before peak seasons, while post-season sell-downs reduce availability.
- Sales Volume: Higher sales typically generate more accounts receivable, increasing the borrowing base (assuming collections remain current).
- Collections Performance: Aging receivables can become ineligible, reducing availability even if total receivables remain constant.
- Inventory Composition: Shifts in inventory mix (e.g., finished goods vs. raw materials) can impact advance rates and eligibility.
- Customer Concentration: Growth in sales to a single large customer may trigger concentration limits, capping the eligible receivable base.
Why Lenders Discount Inventory & Receivables
Advance rates represent a lender's assessment of risk-adjusted liquidation value, not book value. Several considerations drive these discounts:
Liquidation Risk
In a default scenario, assets must be liquidated to recover loan principal. Lenders apply discounts to account for potential losses during orderly or forced liquidation processes.
Collectability Uncertainty
Not all receivables will be collected at face value. Customer disputes, credit risk, and economic downturns can impact recovery rates.
Inventory Marketability
Inventory values can deteriorate quickly due to obsolescence, fashion changes, or industry disruption. Lenders discount inventory to reflect this risk.
Cushion for Over-Advances
Conservative advance rates provide a buffer to prevent over-advances if asset values decline between reporting periods or field exams.
Illustrative Example
Consider a hypothetical retail distribution business with the following balance sheet assets:
Illustrative Borrowing Base Calculation
This example is illustrative only and does not reflect actual lending terms or availability for any specific business.
In this example, the borrowing base of $2,695,000 represents the maximum amount the business could borrow at this point in time. As accounts receivable and inventory levels change (due to sales, collections, inventory purchases, etc.), the borrowing base will adjust accordingly.
This article is for educational purposes only and does not constitute financing advice or a recommendation of any lender or financing product. All financing decisions should be made directly between you and a lender.