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Auto Focus

By Melissa Anderson
Vice President, IRN Inc.
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As Peter Drucker said, the purpose of business is to create and keep a customer. But in order to do that in a sustainable way, you have to mind the money. My colleague Gary Burns, IRN’s VP of the financial advisory services, and I were talking recently about the options a client had for meeting its financing needs. He pointed out that asset-based lenders are back in business, so to speak, and could be a reasonable resource. Here’s how Gary laid out what has been happening in the financial world relative to automotive component makers and why asset-based lending might be a good route to take again, after a challenging period.

Suppliers generally need additional capital for a variety of reasons. When the economy was bad, capital was needed to make up for lost business and to ease the resulting strain on operations. As the economy improved, capital was needed to fund increased sales and to ease the corresponding strain on working capital. Many people have been discovering, with the recent swing of the business cycle, that a profitable and viable business can struggle to avoid going broke, as cash is eaten up by rising accounts receivable and the costs to build up inventory to meet orders.

Banks were not much help during the economic downturn, having their own widely publicized issues. In the past, suppliers needing capital could expect to receive thoughtful assistance from a bank workout group, or eager participation by a bank in a company’s growth. In the past few years, the situation was very different, however. Banks and other traditional sources of capital were nowhere to be found.

That left companies to look for alternative business solutions. Their attention turned to the value locked in the assets that they held. What were they worth in a lending situation? Asset-based lending, the business of relying on collateral rather than creditworthiness, had a long tradition of allowing companies to convert these asset values to cash. On the downside, the pledged assets, such as accounts receivable, inventory, property and equipment, were at risk of immediate foreclosure if the borrower violated the terms, so this has traditionally been one of the last options for raising capital.

In the Great Recession, asset-based lenders were also caught up in the turmoil, however. Many of these players began looking past the assets to also evaluate the short-term operating performance of the company, discounting the value of unencumbered or otherwise available assets. Asset-based lenders were asking for operating covenants (like EBITDA or net income targets), even though they were more than adequately covered by pledged assets. And the lending value of illiquid assets, like real estate, practically disappeared.

This behavior of extreme caution and heavy demands by asset-based lenders may be changing. Recently we have seen signs of the reemergence of the more traditional practice of the asset-based lending community. More competition now exists for providers of capital, which gives borrowers some options previously difficult to find, with better terms and conditions.

What does this mean for a company looking for capital? You can expect an asset-based lending institution to be back to the fundamental approach of inspecting the assets, and requiring regular (some would say “constant”) reporting on the ledger accounts. How much do you have in accounts receivable and inventory? What price are you selling it for? The asset-based lender provides funds so that you can bridge the gap between cash out for materials and cash in from sales as you operate your business profitably. In addition to the return to standard operating procedure, we have observed one new element of the process, i.e. the lender is likely to be interested in whether the company has a clear understanding of the purposes of the additional capital and a solid plan for its use. That is part of their assessment of the viability of the business going forward.

For a supplier, the information that the asset-based lender requires is what you should be using anyway to monitor your operating results under any circumstances. Having a budget that projects revenue, expenses and asset values into the future, is an important management tool. Tracking the changes in working capital, including cash, accounts receivable, inventory and accounts payable, will allow for resource management that both the company and the bank should expect to follow. A well-considered financial plan based on operating realities will allow a company to tap the improving asset-based lending market.

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• asset-based lending
• auto focus
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• irn
• manufacturing
• melissa anderson