Borrowing Base: What It Is & How To Calculate It
Tom has 15 years of experience helping small businesses evaluate financing and banking options. He shares this expertise in Fit Small Business’s financing and banking content.
This article is part of a larger series on Business Financing.
The borrowing base is the maximum amount of money that can be borrowed based on the value of a company’s collateral for an asset-based loan. Generally, lenders won’t provide financing equal to 100% of the collateral value, instead offering financing based on a discount factor. The value of the collateral multiplied by this discount factor or advance rate equals the borrowing base.
For example, if a lender has a discount rate of 20% on accounts receivable, it is willing to lend at 80% loan-to-value (LTV). The 80% in this example is also termed the advance rate. A lender may disclose either the advance rate, the discount rate, or the LTV threshold. The discount rate a lender applies to asset valuation may vary based on the type of asset being considered. While a lender may require an 80% LTV as a borrowing base for equipment, the lender may only allow a 50% LTV borrowing base for inventory. Before estimating your available borrowing base, ask your lender what discount rate they require.
How to Calculate Borrowing Base
1. Determine the Value of Your Inventory
When determining the value of your inventory for the borrowing base, use the present market value of the inventory. This is the value of the inventory if it were all to be sold today and not the amount you paid to acquire the inventory. Inventory valuations conducted by the lender may require an on-site inspection.
2. Determine the Value of Your Equipment
The valuation used for equipment should be listed as the current value of the equipment and not the initial retail value. You need to account for depreciation when determining the current value of any equipment being considered in the borrowing base. A lender will use the depreciated value on any ongoing borrowing base certification.
3. Determine the Value of Your Accounts Receivable
Typically, the only accounts receivable (A/R) that lenders will accept as part of the borrowing base are those that are due within 90 days. The value to be included for A/R is the sum of all eligible invoices. Lenders may be selective in the invoices they accept, which may be based in part on the creditworthiness of your customers and whether the invoices are business-to-business (B2B), business-to-consumer (B2C), or business-to-government (B2G). Some lenders are only willing to lend on invoices to business or government accounts.
4. Apply the Discount Rate or Advance Rate
Once you have determined the values of your assets, you will multiply each type of asset by the applicable discount rate. Keep in mind that lenders may have different discount rates for different asset types. To get the most accurate estimate of a borrowing base, you will need to be familiar with the various discount rates.
After applying the discount rate to each asset type, you will then add the three figures together to determine the borrowing base. This is the estimated maximum amount that a lender will be able to loan to you based on your current assets. In most cases, the lender will continue to reverify the value of the pledged assets throughout the course of the loan.
What Is a Borrowing Base Certificate?
A borrowing base certificate is used to list all of your available assets that can be used as collateral for a loan and to determine the borrowing base using the discount rate of the lender. This certificate is the formal calculation the lender uses to determine the maximum amount of financing it can offer.
Sample Borrowing Base Certificate
Image Source: www.publishedguides.ncua.gov
Borrowing Base Monitoring
When a business takes out a loan based on a borrowing base agreement, the lender usually will require you to file an updated borrowing base certificate at regular intervals. This requirement is to ensure that the business still meets the base requirements for the remaining loan balance.
In the event that the collateral value falls below the prescribed borrowing base, the business will need to repay enough of the loan to bring the financing back into compliance. It is your responsibility as the borrower to ensure the updated borrowing base certificates are completed in full, are accurate, and are provided to the lender on time.
When Borrowing Base Is Used
The borrowing base is most commonly used to determine the potential loan amount you are eligible for when applying for an asset-based loan. While there are additional qualification factors involved in eligibility for an asset-based loan, your loan amount will be tied predominantly to your eligible borrowing base.
Types of Asset-based Lending
Many types of assets can be used to establish the borrowing base for an asset-based loan. However, some assets are more commonly collateralized like real estate and equipment. Inventory, A/R, and other tangible assets can also be used to back small business loans.
The most common types of asset-based loans include:
- A/R financing: A/R financing uses your current customer invoices to determine the borrowing base for a business line of credit. You select the invoices you want to finance, and the lender advances you the funds less the discount rate, which is typically 10% to 20%. Then, you pay the lender back as customers pay you.
- Invoice financing: Also known as factoring, invoice financing involves assigning invoices to a factoring company. The factoring company purchases your invoices and advances a portion of the invoice’s value to you. Your customers pay the factoring company instead of you. The factoring company then advances you the remaining amount of the invoice, minus the factor rate and any fees.
- Inventory financing: Inventory financing uses the value of existing or future inventory as the borrowing base for a small business loan or line of credit. Using inventory as collateral is slightly more complicated than using real estate or equipment due to fluctuating inventory levels. Lenders may require you to update borrowing base certifications more frequently so that the loan remains properly collateralized.
- Equipment financing: Equipment financing uses the value of equipment you already own or are purchasing to determine the borrowing base for financing. Similar to a personal auto loan, the business equipment protects the lien. If you default on the loan, the lender can take possession of the equipment instead of repayment on the remaining debt. Borrowing base certification updates are necessary due to equipment depreciation.
- Real estate financing: The equity in owned real estate can be used as the borrowing base to secure a loan. Typically, this is referred to as an equity loan rather than asset-based financing although, by definition, it is a type of asset-based loan. Most major banks offer commercial real estate equity loans. Lines of credit can also be collateralized through commercial real estate.
- Other tangible assets: Though it is not very common, it is possible to use assets other than those named above as part of the borrowing base for a loan. In general, if you have a tangible asset that has value and a lender is willing to accept it, you can use it as collateral for a loan. Transactions of this type generally require a professional valuation to determine the value of the item intended to be included in the borrowing base.
Bottom Line
Lenders use the borrowing base to determine the maximum loan amount that can be offered to a borrower on an asset-based loan. Each borrowing base is unique and determined by the borrower’s available assets along with the lender’s discount rate or acceptable LTV ratio.
