(1) Machinery, Equipment and Motor Vehicles
Many banks provide working capital loans and secure themselves with assets as listed on the balance sheet. Some of these assets include accounts receivable and inventory that are a part of current assets. Machinery, equipment and vehicles are part of fixed assets, meaning that they have a longer lifespan than current assets. Normally fixed assets are listed on the balance sheet at book value. Their net value is shown after deducting accumulated depreciation. All other things being equal, here are some issues a lender should consider before making a loan:
• Are these assets encumbered and if so, do liens, notes exist?
• Who are the lien holders or legal owners of the assets being pledged as collateral?
• Obtain an assets schedule listing each asset, date purchased and purchase price.
• Are the assets subject to lease or consignment agreements, if so, review them carefully or simply allocate zero values to such assets in your collateral analysis.
• Examine the type of insurance coverage to ensure it is adequate and your interest in the assets is recorded.
• Assets should not be under threat of litigation.
• The asset loans should be current without a history of default.
• Obtain a professional valuation of the assets, if it makes make economical sense to do so.
• As a rule of thumb, in absence of a professional valuation, pledged machinery and equipment should be valued at a maximum of 25% of book value based on audited or reviewed accounts.
• If the asset does not have a certificate of title, the risk of the asset being disposed off without the lender's knowledge is imminent.
• How will the lender ensure that the assets are maintained in good condition? Monitoring of maintenance records can be a costly affair.
• Machinery and equipment collateral is weak. One should be careful when lending based on such collateral.
(2) Inventory
Inventory, commonly used to secure asset-based lending (ABL), is composed of goods other than farm products held for sale or lease or to be furnished under contracts of service; or consist of raw materials, work in progress, or materials used or consumed in a business.
Asset-based lending is generally revolving credit secured by inventory that is monitored constantly. Source of repayment is collections from sales. If you take inventory as collateral, then you must make sure that;
•You value the inventory periodically to determine whether or not the collateral value is retained. Valuation should be at cost or market, whichever is lower.
• You only finance high-quality inventory that will remain marketable and maintain its value.
• You discount the value with your estimated cost of liquidation and value depreciation based on forced sale value. Generally, banks discount values by 50% or more based on the quality and marketability of the merchandise.
• In addition to taking the entire inventory collateral (not a portion), endeavor to strengthen collateral cover by taking accounts receivable as well.
• You examine numbers carefully and make physical inspections periodically, at least once a quarter or more frequently as needed.
• You review financial statements to identify any signs of deterioration in performance, i.e. sales, gross and net margins etc. In particular review the budget, quality of receivables and payables.
• Advances are only made for payment of the purchase price of goods.
• In case of leased goods, include in collateral, the chattel paper generated by the sale of inventory.
• You obtain a manufacturer's repurchase agreement, if possible.
• You don't forget to file your UCC lien.
Franc Jo is a Senior Underwriter at http://www.loansunderwriting.com, the leading provider of outsourced Commercial Credit/ Underwriting support to lenders and funding solutions to small businesses throughout USA. Find similar articles and tips on money matters at http://www.loansunderwriting.com/Pages/Articles.aspx
