Inventory Advance Rates

Inventory advance rates are used to limit the amount a Lender has at risk when inventory is used as collateral.  For example, let’s say ABC Company has $5 million worth of Inventory.  In an Asset Based Line of Credit structure, the collateral value of the Inventory may be between $1.25 million (25% advance rate) and $2.5 million (50% advance rate).

Lenders use advance rate formulas to protect themselves against the risk that a Borrower will default on the loan.  If that occurred, the Lender would take steps to control the business assets (A/R and Inventory) and convert them into cash to recover the outstanding loan balance.  Thus, the Inventory advance rate should be set to allow the Bank to fully recover loan proceeds.

Items that can be easily sold with well established markets and prices generally receive the highest advance rates.  These are typically commodity products in raw material form.  Examples would be metals, lumber, bulk agricultural products, some seafood products and non-toxic materials.  Maximum recommended advance rates are usually 50% of the total value of these items.

The next step down would be Inventory consisting of readily saleable finished goods.  These are items that have wide acceptance and use in the marketplace.  These items are not subject to seasonality, demand, style, mix and/or composition.  Examples are engines, large industrial tools, equipment, brand name finished goods, and some consumer goods (such as flat screen TV’s and large appliances).  Maximum recommended advance rates for these types of goods are 40% to 50%.

Less desirable Inventory includes saleable finished goods that may have broad acceptance, but the mix and identification of the Inventory may affect its liquidation.  Examples include auto parts, small appliances, office supplies or marine parts.  The maximum advance rate recommended on this type of inventory is 25% to 40%.

Common sense should be the overriding factor in choosing an Inventory advance rate.  Lenders should always consider how difficult it will be to liquidate that Inventory in calculating an advance rate.

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