Working Capital Financing 101 (Part Two)

If you want to set yourself apart from the herd and become a Business Banking Rockstar, you need to master your craft!  Learn everything you can about business credit products, credit policy, financial analysis and credit underwriting.  This article will help get you on the path to becoming a Business Banking Rockstar. This is the second part of a how-to guide I published a few months ago.  You can access the how-to-guide (part 1) using the following link: https://www.bizpetrol.com/Download-Working-Capital-Financing-101. In this article, you will learn how to quickly estimate if you have enough trade asset support for a large business line of credit request. 

You will need an Accounts Receivable Aging Report and a current financial statement from your client or prospect.   You can either do a rule-of-thumb estimate or AR analysis quickie! 

Rule-of-Thumb Estimate:  it is very easy to do. You take 80% of total AR and 50% of total inventory and add them together.  If you have $1,100,000 in total AR and $750,000 in inventory, you take 80% of $1.1M ($880,000) and 50% of $750K ($375,000) and add them for a total of $1,255,000. This means that the business’ trade assets can potentially support a $1,255,000 line of credit.  However, this is a very rough estimate.  If you want to dial it in and look like a Rockstar with your prospect and your credit team, you can do an AR analysis quickie!

AR Analysis Quickie:  this is a bit more involved but you can still get it done fast.  You will need to do a few calculations as follows:

• Look For Concentrations: banks typically define a concentration for a single receivables account based on a percentage of total receivables as.  g. a single account balance that exceeds 25% of total receivables. Any amount of the single account that exceeds 25% of total receivable is considered ineligible.  Using our Rule-of-Thumb example above, 25% of total AR is $275,000.  Look at the AR Aging Report your prospect gave you and look for any customer account that is greater than $275,000.  For example, let’s say you find an account for ABC Seafood that has a total balance of $300,000.  The ineligible portion of that account is $25,000 ($300,000 - $275,000).  You would subtract $25,000 from the total accounts receivable balance ($1,100,000 - $25,000). Do this for each account that has a concentration.
• Look For Cross-Aging: cross-aging is the practice of making all the AR from a single customer receivable account ineligible to be included in the borrowing base if a specified portion of the total AR from that customer is delinquent.  Also, sometimes referred to as the “10 percent rule” since a common delinquency threshold is 10 percent.  Look at the AR Aging Report again.  You will typically see columns titled Current, 1-30 Days, 31-60 Days, 61-90 Days and Over 90 Days.  Any account balance that shows up in the Over 90 Days column is considered delinquent. If a customer account has 15% or more of its AR categorized as delinquent (greater than 90 days), the entire amount of the account debtor’s AR is ineligible until the delinquent amount is cleared through collection.  Let’s say that Rockstar Fish has a total AR account of $75,000 and $30,000 of the balance is showing up in the Over 90 Days column.  $30,000 is 40% of the total account ($75,000). If your bank uses the 10% rule (it could be higher, e.g. 15%), this would mean that Rockstar Fish’s entire account is ineligible. You would subtract $75,000 from the total accounts receivable balance.  Do this for each account that has a balance in the Over 90 Days column.
• Other Ineligible Accounts: Concentrations and Cross-Aging ineligible accounts are the most common ones.  Your bank may also eliminate foreign accounts, government accounts, or healthcare accounts. You can chat with your credit team about this.
• Calculate Estimated Eligible AR: if you only had the two adjustments above, your eligible AR would be $1,000,000 ($1,100,00 - $25,000 - $75,000) instead of the $880K based on the Rule-Of-Thumb approach. But it could also be lower if there were several concentrations and cross-aging accounts you had to eliminate. 

Bizpetrol has information, knowledge and tools that will help you become a Business Banking Rockstar.  You can start elevating your business credit skills using the free Commercial Lending Toolkit at www.bizpetrol.com. You can see all the Business Banking News articles (like this one) at www.bizpetrol.com/blog. You can access a series of how-to business banker guides https://www.bizpetrol.com/Downloads-Free.

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