Field Audits in Asset Based Lending. Definition and Example.

Asset Based Lending or “ABL” has grown in popularity, and is now the number one method of financing working capital for middle market business borrowers {middle market defined as those business entities with sales between $20 Million and $1 Billion per year}. The attractiveness of ABL to lenders is clear when the two main characteristics {Control and Self-liquidation} are analyzed.

Control: Asset Based Lending provides a large amount of control to the lender. It wasn’t long ago that open lines of credit used to be the norm. Under open lines of credit, a business can borrow up to the commitment amount, but the business’ financial condition was only known to the lender during the annual review or at best on a quarterly basis if the loan agreement required the submission of quarterly financials.

The fact that advances under a line are tied up to specific working capital assets under an ABL {usually accounts receivable and inventory} and that the borrower has to report the level of eligible assets on a monthly basis to the lender are control tools that assure the lender that:

a)       The loan is being used for its true purpose and not diverted.

b)      There is enough of an early warning of the borrower’s performance deterioration so that the lender can take a protective action.

Self-liquidation: The other benefit of working capital ABL facilities is that because they advance on trade assets, it is more likely that the money will be collected even in instances where the business revenue decreases. After all, eligible receivables are only those where the sale has already occurred, and the merchandise has been shipped. The good thing about ABL is that the lender relies not only on the business to repay, but also on the business’ customers that bought on terms.

Why Field Audits?

Because there is so much reliance in the assets when lending under an ABL facility, it is very important for the lender to confirm that the information provided is correct. Field audits are usually performed by independent third-party professionals, and they include the financial review of the borrower’s financial records.

What are the Field Audit Types?

Field audit types are classified by the amount of detail, testing, and verification involved. The two main classifications are:

Limited Scope: Involves a basic review of the business’ cash accounts, checking accounts “cancelled checks”, accounts receivable, inventory, accounts payable, taxes and insurance. The field examiner will normally test the latest borrowing base certificate against the A/R aging and determine if the borrower is following the ABL agreement regarding eligible assets and adjustments. Usually the latest set of financial statements is analyzed and trends are identified. The general ledger is reviewed and analyzed.

Full Scope: Involves the above, but it goes into a much greater level of detail. Usually, the field examiner will request 12 months of history for A/R and A/P. It might also involve reviews of specific accounts to insure that the business is paying its obligations on time.

Is there anything that one should know about Field Audits?

From personal experience, it is important that the audit actually verifies with the business customers the validity of the A/R. Records can be falsified, but it is harder to do when the auditor performs random verifications with customers.

Where can I get an Example of a Field Audit?

Audits are usually 10 to 50 pages long not counting any attachments and exhibits. That would be a little too much for a web article. However, I can give you an idea of the components by listing them below. Take into consideration that this is the format used by one particular field examiner, and that the industry is very fragmented with thousands of practitioners in the US.

Sample Audit Structure follows:

Business Name

Field Examination Report

Date X/XX/XX

 

  1. SCOPE OF THE EXAMINATION
  2. SUMMARY
    1. Strengths
    2. Weaknesses
  3. COMPANY OVERVIEW
  4. FINANCIAL RECORDS
  5. ACCOUNTS RECEIVABLE
    1. Aging Spreads and Turnover
    2. Sales & Dilution
    3. Concentrations
    4. Past Due Analysis
    5. Tests (Shipping and Credit Memo)
    6. Ineligible Receivables (Comparison with Company)
  6. INVENTORY
    1. Composition
    2. Tests (Count, Cost, and Gross Profit)
    3. Insurance
  7. AVAILABILITY
  8. ACCOUNTS PAYABLE
    1. Aging Spreads and Turnover
    2. Concentrations
  9. CASH ACCOUNTS
  10. TAXES
  11. FINANCIAL HIGHLIGHTS AND TRENDS
    1. Income Statement Highlights
    2. Balance Sheet Highlights
  12. ADDITIONAL INFORMATION

You can get additional information on this subject by buying the following books from Amazon: Essentials of Working Capital Management
or Get Financing Now: How to Navigate Through Bankers…..

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