Borrowing Base Certificate: a Worked Example

An overdraft has a limit that stays put until someone changes it. An asset-based facility has a limit that moves with its collateral: as debtors are collected and stock is sold, the amount the lender will advance changes, faster than any credit review could follow. The certificate keeps the limit current. The borrower produces the figures because they come from its own sales ledger and stock system; the lender writes the rules for what counts. The signature matters. An officer of the borrower certifies the figures, and in many agreements a materially wrong certificate is a default in itself.

Frequency follows risk. Monthly reporting is common, and weekly or even daily reporting is used where collateral turns over fast or the borrower is under strain. In the United States, the national-bank supervisor's handbook describes weekly or monthly certificates as common in asset-based lending, with field examinations before the facility is booked and regularly after, often quarterly. Asset-based lenders in New Zealand, Australia and the UK work to broadly similar routines, set facility by facility.

Every line is a definition in the agreement. Ineligibles are the invoices the lender will not lend against, for reasons running from age and cross-ageing to contra balances with customers that are also suppliers. Reserves are amounts held back for risks the advance rate does not cover, such as the cost of collecting the ledger after a default, or claims that would be paid ahead of the lender in an insolvency. Some employee entitlements are among those claims in all three markets, but each reaches different collateral: in the UK, assets under a floating charge; in Australia, assets under a circulating security interest, which a purchase of the debts is not; in New Zealand, receivables and inventory, unless the lender's interest is a perfected purchase-money interest or a perfected purchase of the receivables for new value. Where stock is in the base, its advance rate is commonly lower than on receivables and set with an eye to what the stock would fetch in a sale.

A plumbing and heating distributor, constructed for this page, has a US$7.5m facility secured on its debtors and stock. Its month-end certificate, in US$000, uses the agreement's rates, which are the example's and not a market norm:

The quarterly field examination tests the certificate against the books and finds two things. Invoices of US$300,000 dated the last day of the month were for goods dispatched in the first week of the next, so they were not yet debts. And credit notes of US$250,000, issued after month-end, related to goods returned before it. Both come out. The stock line stands, because the warehouse system counted both lots of goods at the month end; on the certificate they were being lent against twice:

The certificate showed US$260,000 of headroom; the true position was US$180,000 over. Neither finding needed dishonesty. Invoicing ahead of dispatch to meet a month-end target, and booking returns slowly, are habits of a busy finance team. Together they overstated the base by US$440,000, and the agreement requires the excess to be repaid, in this example within two business days, at the point the borrower's cash is tightest.

The certificate is a summary, and the lender checks it against what sits underneath. The aged debtors report should total to the gross receivables line, and the sales ledger should agree with the general ledger. Receipts should match what reached the collection account. And the debtors should roll forward:

A gap in the roll-forward means something entered or left the ledger outside the normal flow. Dilution, the share of invoices that end as credit notes rather than cash, shows whether the advance rate still leaves enough margin. Between examinations, lenders confirm balances with debtors where the facility allows it, test samples of invoices against delivery records, and watch trends: ineligibles rising as a share of the ledger, cash received falling against sales, a certificate that lands just under the limit month after month.

DEFINED IN ONE PARAGRAPH → · AVAILABILITY → · ELIGIBLE RECEIVABLES →

At approval, the question is whether the borrower can produce an accurate certificate at all: a ledger that ages invoices correctly, a stock system that counts at cost by location, a finance team that books returns when the goods come back. A lender that doubts the systems can lower the advance rate, add reserves or ask for more frequent reporting. Each of those terms is negotiated, and each is availability given or withheld.

In monitoring, the certificate is often the earliest warning a lender gets. A business under pressure tends to show it here first, in rising ineligibles, in credit notes booked later, in invoices raised a little earlier each month. A credit officer who reads the certificates as a series rather than one number at a time sees the pressure before it reaches the accounts.

PRODUCT FILE: INVOICE FINANCE → · WHAT TO SEND YOUR BANK EACH MONTH →