As businesses grow and have more of a need for working capital a valuable financing tool is the 'operating line of credit '. This facility is also commonly called a 'revolver' by finance professionals.
What is the revolver? It is a financing facility, most commonly done with a bank that provides credit against the customer's receivables and inventory.
How does the facility work? After the facility is approved and negotiated with the bank the customer submits, usually monthly, a detailed list the firms account receivables and inventory. The bank calculates what is known as a 'margin limit 'and advises the customer that the business can write cheques against that overdraft, or line of credit up to the maximum of that margin limit.
That new limit is of course approved until the next month's receivables and inventory are reported on by the customer. We would say that in 99% of industries the reporting by the customer is done once a month, but on occasion it can be more regular with some customers, and on rarer occasions it can be less often.
How does the bank or financial institution calculate the approved amount? Typically the bank looks at the accounts receivable and calculates how much of the receivables less than 90 are days old. Banks assume there is a high level of uncollectibility on receivables older than 90 days. This may or may not be the case according to the customer - but the bank makes the assumption on the conservative side. (What a surprise!) Given that the bank now has an amount of A/R less than 90 days they take 75% of that amount, typically, and use that as the credit limit. A similar calculation is done for inventory.
The inventory calculation is a little trickier. Why? That is because the bank understands receivables and could step in to collect them if they had to - however, they don't understand inventory, and their customers have all types of inventory! Our experience is that as a rule the banks will pick an amount close to 40% for the inventory portion of the credit line. So if a customer has a month end balance of 200,000.00 in inventory the bank will arbitrarily allow them to write cheques of 80,000.00 against the inventory.
The bank has now calculated the facility based on our above A/R and inventory figures.
It is very important to know that the whole exercise with the bank is subject to a number of other factors, such as the profitability of the business, the risks associated with the customers industry, and any personal guarantees that also support the facility.
In summary, operating lines of credit are important, dare we say critical, to a customer that is growing and needs working capital. More cash is available, per our formulas, as the business grows. Problems can arise when a business is no longer growing though - the bank restricts the borrowings, less cash is available, and supplier payables place pressure on the company's working capital. It is also important to note that if the operating lines of credit are significant the customer may lose focus on profits and operations, thinking he or she has all the cash they need. That's not good. Business owners are cautioned to used operating lines properly, and also focus on their profits and operating capabilities.
7 Park Avenue Financial is an expert in Mississauga Ontario asset based lending. We’re known for our exceptional track record in sourcing loans for our clients – why not take a look here? We have originated millions of loan dollars for our clients over the past years, and we know what it takes to make a difference in your business.
There are various types of secured lending in the Canadian business environment. Let's examine some of those secured loans and discuss some of their characteristics.
When most business owners or financial managers think of secured lending they are thinking in terms of their operating loans or operating lines of credit, sometimes called ' revolvers' in finance language.
These loans are used to financing working capital, primarily receivables and inventory. In taking and registering this security the bank or some similar financial institution will take an assignment of these 'liquid assets' of the company. On occasion customers will hear the term ' demand loan ' and we are in effect talking about the same thing.
How does the bank or other institution secure the loan? They register what is known as a General Security Agreement, commonly called a 'GSA 'against the business. In determining their security and overall all 'credit limit' with the customer they usually agree to advance against 75% of all good receivables, and some component of inventory. We can, as a general rule, say that banks don't really like inventory - simply because they aren't set up to liquidate on it when they have to.
If everything goes well that is as much as the business owner really needs to know. The loan is secured, the bank registers a public security against the company, and the company has access to working capital.
How does the Secured Lender realize on the security? Again, we are talking about the worst case scenario when a bank has determined it needs to 'call the loan ', terminology most business owners know too well but hope they never have to live through. The bank is in effect, at that time, attempting to crystallize on its loan. In securing the loan we spoke of the bank or other lending institution taking an assignment of the assets. Now that the loan has been called an actual assignment is enforced - customers are notified by the bank and monies are collected by the bank to reduce the loan outstanding. The bank now finds itself in a position of having to deal with the inventory they did not want to deal with, and we typically find that the inventory is directed to be sold by an auctioneer or salvage firm, who acts as a temporary agent for the bank.
When loans are enforced in such a manner the results are usually disastrous for the customer and have a major impact on the company's ability to go forward.
Lenders securities agreements in Canada are all registered under Canada's Person Property Security Act, and are in effect public knowledge for those that wish to investigate secured dealings. This process is very similar to the UNIFORM COMMERCIAL CODE (UCC) that exists in the U.S., and in fact the security legislation in Canada was very closely model to the U.S. way of secured lending notification.
There are other forms of secured lending Vis Vis equipment, debentures, and security is generally handled in the same manner re: registration, etc.
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We want to help you secure an asset based loan, and we’re here to answer any questions you have about how we can make asset based lending work for you. Why not call today and allow us to use our years of expertise to help you move your business forward?
