Borrowing base is the total amount of collateral against which a lender will lend funds to a business. This typically involves multiplying a discount factor by each type of asset used as collateral. For example:
- Accounts receivable. 60% to 80% of accounts receivable less than 90 days old may be accepted as a borrowing base.
- Inventory. 50% of finished goods inventory may be accepted as a borrowing base.
It is also common for a lender to only use the accounts receivable of a borrower as collateral - it may not accept any inventory as part of the borrowing base.
As an example of a borrowing base, ABC International applies for a line of credit. ABC has $100,000 of accounts receivable and $40,000 of finished goods inventory. The lender allows 70% of the accounts receivable and 50% of the inventory as the relevant borrowing base, which means that ABC can borrow a maximum of $90,000 (calculated as $70,000 of accounts receivable and $20,000 of inventory) against its collateral.
A business that borrows money under a borrowing base arrangement usually fills out a borrowing base certificate at regular intervals, in which it calculates the applicable borrowing base. A company officer signs the certificate and submits it to the lender, which retains it as proof of the available amount of collateral. If the borrowing base stated on the certificate is less than the amount that the company is currently borrowing from the lender, then the company must pay back the difference to the lender at once.
Careful monitoring of the borrowing base is of particular importance in seasonal businesses, since the inventory portion of the base gradually builds prior to the selling season, following by a sharp increase in the receivable asset during the selling season, and then a rapid decline in all assets immediately after the season has been completed. It is necessary to balance loan drawdowns and repayments against these rapid changes in the borrowing base to ensure that the company does not violate its loan agreement.