Monday, September 3, 2012

Recently I had a discussion with one of my clients on the difference between cash flow lending and asset based lending (ABL).
It started with a Line of credit (LOC) offer made by a bank to my client. The Bank said that they will lend money on the AR and Inv. of the company (up to a certain percentage) with certain restrictions. My client jumped on this offer as a way of infusing additional capital into the company’s working capital investment. He was going to buy more, pay AP more and he was excited! I examined the Bank proposal in detail, having had some experience in ABL lending and explained to the client, that there was no extra money, only early money !!. Wow ! this created a whole level of complexity……We talked of the Borrowing Base, lockbox, unrestricted use of cash during a month and then a true-up etc .
I had to approach my explanation in several different ways before my client got it!
This was the winning explanation
Any company has a cash conversion cycle ( also called the working capital cycle) – (1). AP becomes (2) Inventory which becomes (3) AR which becomes (4) Cash and is used to pay AP and the process starts all over again.
The Bank offering to lend on an ABL means that you can get money before (2) and (3) are converted to cash. Once you have obtained this Cash from the Bank as a loan upfront, you cannot use (4) as this now belongs to the Bank under the ABL terms. That is because, as Cash is collected your AR goes down ( therefore, so does the collateral to the Bank which needs to be replaced by new AR). If (2) and (3) expand you are able borrow more and if it contracts you are able to borrow less during the next month. My client was under the impression that he can use this cash collection in addition to the loan obtained upfront. This is only possible under a cash flow lending scenario.
Here the firm pledges AR and INV ( or any other asset) at a certain point and the bank gives a loan. There are parameters set, but essentially the movement of AR and INV (as long as they are within these parameters) can be controlled by the firm and all the collections belong to the firm without restriction. Then the loan creates additional capital and the unrestricted movement of cash collections and disbursements occur without recourse to AR being replaced. This then is the essential difference of the workings between a Cash flow loan and an ABL loan. This difference has an impact on the working capital cycle. In one cash collections belong to the Bank in the other it belongs to the company. In the ABL scenario, for the next month the working capital cycle is checked before new monies are released under the loan. Under the Cash flow scenario you have access to the loan ( or any balance) in addition to your cash collections.
Cash flow loans are usually available to companies with strong Balance Sheets and ABL to lesser credit worthy companies. It behoves you to study these offers carefully. Determine whether it is early or additional capital. I wonder how many firms understand this and how many get into problems once they have accepted an ABL offer?

Mohamed Noohu

Mohamed Noohu

MSNCFO founder Mohamed Noohu has over 25 years of varied work experience as Controller, CFO, and business owner. His background reflects diverse industries, company sizes and stages of growth, including very large, well-established multi-nationals in the oil services, logistics, transportation and Insurance industries, mid-sized companies in electronics distribution, and several start-up companies.

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MSNCFO provides many opportunities to intermediate accounting students. Throughout my 3.5 years of working with the company, I was able to improve my existing skills,

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