Warren Buffet said, "The cash is what oxygen is to companies for people." Today, this reflects the concerns of SME owners affected by the breakdown of payment chains due to restrictions imposed by governments to mitigate Covid-19.
Although several governments have introduced financial support initiatives to ease the blow, in many cases they have not reached businesses. The reason is the absence of free assets available as collateral for Covid loans without state guarantees to cover part of Covid loans that are not guaranteed by the State. The lack of accounting records attached to some small companies, often covering no more than some bank statements and a list of receivables, is another reason for this failure.
Asset-based loans
There is a tool widely used in North America that can be useful for SMEs wishing to release payment chains. This tool is known as an asset-based loan (ABL) and is a loan under the lien of trading assets. ABL is a revolving loan in which the borrower's receivables and stocks are both the main and secondary sources of repayment. The book value of these assets supports a loan granted by the lender and their collection (or sale and recovery) generates cash flows to repay the loan.
Example
Production activities were disrupted by restrictions Covid-19. When Covid-19 It also affected the company's customers, the company used all available cash to cover wages, municipal services and some suppliers.
When the restrictions allowing the company to resume operations were abolished, it turned out that there was not enough cash to reopen and resume production. The company has stocks of book value 100,000 USD, of which raw materials and finished products, and charges of 60,000 USD.
ABL allows the lender to credit 50% the value of their stocks and to 75% their debts. In this example, a loan of up to 95,000 USD (50,000 + 45,000 USD).
As the company has now cashed in its receivables and stocks in its account to obtain a loan, its ability to create further debt by re-inducting funds into the maximum credit line is limited, pending repayment.
The reporting cycle of balances and the setting of the maximum amount of a renewable credit line shall be repeated every 30 days or more for high risk borrowers. As a safeguard measure, the lender uses audit firm services to verify what six months of accounting balances reported by borrowers.
Asset-based loans offer benefits to both borrowers and lenders. The borrower obtains the funds necessary to operate without having to offer the lender as collateral for the assets or financial assets. In turn, the lender can objectively assess its risk and exposure by charging cash-in assets. The security margin created by the granting of the loan only under a certain part of the assets gives the lender relative confidence in the recovery.
In Peru, the provisions on pledges on financial means require the appointment of a trustee or trustee of these assets. This role entails civil and criminal liability. Although the initial and ongoing control of the underlying assets is at the expense of the borrower, this is usually offset by the lower interest rate that the lenders collect, taking into account their relative certainty of recovery.
ABL requires the involvement of an experienced audit firm. In addition to the formal documentation needed at the outset, an asset valuation should be carried out.
This requires a detailed audit of the receivables in order to verify that they are supported by the relevant customer orders as well as by the relevant shipping and delivery documents. The nature, state and rotation of stocks also require careful examination.
Only after these audits can the lender determine how much he is willing to borrow – he determines the basis of the loan.
In conclusion, ABL as a tool for lenders and borrowers are potentially useful in the current environment. Of course, this method of credit requires the support and approval of local financial authorities. In Peru, despite the favourable legal framework for the lien of working assets, bank rules consider only stocks held in tax warehouses, set by warrants to be preferred. Developing your own rules belongs to other countries.
Author: Jesús Fernando De la Torre Lima, Peru
He is a specialist in corporate finance and international banking in Russell Bedford Perú. She's over 25-years of experience working in the United States, Canada, Panama and Peru in the areas of credit risk management, recovery of difficult and structured trade finance.
He earned a bachelor's degree in business management at the Universidad del Pacífico in Lima-Peru and an MBA from Loyola University in Chicago, IL. It is currently focused on the GRC and ESG, with a particular focus on the ERM and the COSO internal control framework, as well as ISO corporate governance, risk management.