Simon Featherstone, Managing Director of Lloyds TSB Commercial Finance examines asset based lending and its increased importance to effective cash management in the current climate.
The old adage of ‘cash is king’ has never been more relevant than in the current downturn, which has brought cash flow issues into sharp focus.
According to a recent report*, around one in every 50 businesses will fail this year alone, with tens of thousands of insolvencies predicted over the next 18 months as a result of poor cash management.
The treasurer’s part to play in a firm’s success is arguably more crucial than ever before. Such a role has shifted from managing tactical, routine treasury processes to activities that add shareholder value.
As organisations are looking to treasurers to reduce costs, enhance productivity and improve risk management, those in the position are increasingly looking at other ways of generating liquidity.
More and more firms are realising that a key means of strengthening cash flow is to manage the assets of a company more efficiently and effectively.
As a result, asset based lending (ABL), which includes factoring and invoice discounting, is increasingly being considered as a vital tool for managing cash flow, boosting working capital and releasing funds for expansion.
What is ABL?
Typically structured as a revolving line of credit, an asset-based loan is traditionally secured and backed by tangible assets such as accounts receivable, inventory, plant and machinery, and property.
Not surprisingly, interest rates on asset-based loans are often lower than rates on an unsecured loan or line of credit due to the security offered by the assets.
This secured nature of ABL allows it to quickly inject funds into a business in order to provide rapid access to capital. It focuses the firm on its working capital, and its ability to fully leverage the asset base of the company.
Effectively managing funds in this way empowers a firm to be fleet of foot, allowing management to enter new agreements safe in the knowledge that ABL will boost funds immediately and give them the breathing space to confidently move forward.
Arranging ABL
When evaluating a company wishing to take out an asset-based loan, the lender determines the value of a business' assets based on thorough due diligence. The purpose of this is to predict the amount of funding which the facility can generate. This is then compared to the actual cash needs of the company to ensure the cash flow requirements are met.
As part of this process, the provider analyses a company’s books and records, including accounts receivable and inventory, and appraises fixed assets such as machinery, equipment and property.
They will conduct a site visit to see a prospective borrower’s inventory first-hand and assess the strength of the senior management team. The lender is then able to assess a company’s value, weighing qualitative as well as quantitative factors, and provide a bespoke tailored facility.
Advantages and applications
The biggest advantage of ABL is its versatility and flexibility and, in the current climate, there has been increased demand from SMEs to multinationals with complex cross-border requirements.
ABL delivers sophisticated solutions for a variety of scenarios including growth, buyouts, buy-ins, mergers and acquisitions, refinancing, turnarounds and public to private transactions.
For those looking to refinance, whether an existing package is expiring, restricting cash flow or not providing sufficient working capital, ABL is a popular choice.
Over the past decade, ABL has also established itself as an increasingly important source of financing for change events, which help a firm to gain scale.
Many businesses struggle to fund sizeable deals through cash reserves alone and for those not wishing, or able, to take on traditional term debt, or release equity to a third party, ABL is an ideal solution for optimal leverage.
As the market becomes aware of the range and sophistication of transactions that ABL can support, it is being brought into the funding mix at an early stage in the transaction process.
It is rapidly becoming a front line form of finance for many institutional investors and their portfolio businesses and can release the funds needed to execute ‘buy and build’ acquisition strategies.
Its flexibility allows ABL to sit comfortably alongside debt and equity in a deal structure and can implement both value protection and enhancement strategies. Providers will also work closely with a business to structure the optimum set of facilities for the deal.
Funds can also easily be ramped up, should the enlarged company require additional headroom post-transaction in order to capitalise on new opportunities.
Overseas expansion and exporting
Many UK companies with a competitive product or service are taking advantage of favourable exchange rates by entering international markets, in order to drive growth during the recession.
However, the worry of multi–currency trading can be off-putting. Lloyds TSB Commercial Finance can provide currency lines and funding expertise to mitigate against these concerns.
ABL is once again capable of bridging the gap between work completed and the receipt of payments, enabling management teams to execute international expansion strategies without it having a negative impact on the working capital cycle.
Identify and minimise risk
As a result of increasing concern about customer insolvency and the huge negative impact it can have on a business, more companies are using credit rating facilities offered by some ABL providers to identify potential risks where clients may default on paying invoices.
For example, Lloyds TSB Commercial Finance’s Firstcheck system is an online credit rating facility which its new and existing clients can use to obtain credit information on an unlimited number of current and prospective customers.
The service provides credit checks on 3.5 million UK firms and is used to determine payment terms or credit limits for new clients.
It also evaluates current business payment performance data gathered from a daily invoice flow through Lloyds TSB Commercial Finance’s factoring operations, which is one of the biggest in the UK.
As well as using Commercial Finance’s Firstcheck service, an increasingly number of companies are also including debtor insurance policies in their package of ABL facilities.
These agreements take the legwork out of spotting potential credit risk problems before they lead to a bad debt, which also frees up management time to focus on running their business.
Crucially, they ensure firms receive payment of outstanding invoices should a customer become insolvent and protect against the full impact of a bad debt on cash flow.
The economic backdrop has brought the issue of cash management into sharper focus for businesses and particularly amongst treasurers. The ability to closely manage and control capital is a necessity and more firms are taking advantage of ABL tools along with debtor insurance and credit rating policies to not only ensure peace of mind but to manage cash flow, boost working capital and release funds for expansion.
Although it is hard to predict exactly what will happen in the economy over the coming months, we are confident that ABL will continue to cement its position as a mainstream and highly effective financing tool for businesses not only during the tough times but also when the economy is growing.
About Lloyds TSB Commercial Finance
Since it was established 25 years ago, Lloyds TSB Commercial Finance has maintained its market-leading position and pioneered a full ABL approach. This enables clients to draw on a diverse set of assets in order to access a tailored lending solution.
Year on year we’ve increased our client advances and we’re expecting this to continue going forward despite the tough economic conditions.
We’ve also grown our international footprint by opening seven offices across Europe in the past few years in order to support complex, cross-border deals involving multinational corporates.
* Report by BDO Stoy Hayward, Summer 2009
July 2009