What Is a Borrowing Base and How Is It Calculated?
Learn how a borrowing base calculation translates the value of a company's eligible assets, like A/R and inventory, into a dynamic line of credit.
A borrowing base is the amount of money a lender will loan to a company based on the value of its assets pledged as collateral. This figure is used in asset-based lending to provide a flexible line of credit. As the value of the pledged assets, such as receivables and inventory, changes, the amount of available credit adjusts accordingly. This mechanism allows a business to access capital that is directly tied to its operational cycle and sales volume.
Components of a Borrowing Base
The primary assets in a borrowing base are a company’s accounts receivable (A/R) and inventory. For A/R to be “eligible,” it must meet quality standards set by the lender, meaning receivables are current, owed for less than 90 days, and from customers with a solid payment history. Lenders scrutinize the A/R aging report, which categorizes invoices by how long they have been outstanding, to exclude those that are past due. Certain types of receivables are also deemed ineligible.
- Intercompany receivables owed by a parent or subsidiary company
- Amounts owed by foreign customers, unless backed by credit insurance
- Receivables associated with unresolved disputes
- Contra accounts, where the company both owes money to and is owed money by the same entity
Inventory eligibility depends on its quality and marketability. Lenders include finished goods that are ready for sale and not subject to obsolescence or spoilage. The inventory must be in the company’s possession and not held on consignment for another party. The valuation of this inventory is also a focus, with lenders using the lower of its cost or market value for a conservative assessment.
Specific categories of inventory are also considered ineligible. Work-in-progress inventory is a common exclusion because it is not yet a finished product and has limited liquidation value. Slow-moving or obsolete stock, which has not sold within a specified period, is also removed from the calculation. Any inventory stored at a third-party location without an agreement acknowledging the lender’s rights may also be excluded.
Calculating the Borrowing Base
The calculation uses advance rates, which are percentages applied to the value of eligible assets based on their risk and liquidity. Accounts receivable receive a higher advance rate, ranging from 75% to 90%, as they are closer to being converted to cash.
Inventory is a riskier asset because it must first be sold, so its advance rate is lower, falling between 25% and 60%. The specific rate depends on the type of inventory, as commodity products with a broad market might receive a higher rate than specialized goods.
The borrowing base formula combines the advanced values of these assets. It is calculated as the value of eligible accounts receivable multiplied by the A/R advance rate, plus the value of eligible inventory multiplied by the inventory advance rate. This sum represents the maximum amount the company can borrow.
For example, consider a company with $500,000 in eligible A/R and $300,000 in eligible inventory. If the lender sets an 85% advance rate for A/R and a 50% rate for inventory, the calculation is: ($500,000 x 0.85) + ($300,000 x 0.50). This results in $425,000 from receivables and $150,000 from inventory, for a total borrowing base of $575,000.
The Borrowing Base Certificate
The Borrowing Base Certificate (BBC) is the formal reporting document for the loan. It is a schedule prepared by the borrower and submitted to the lender, often weekly or monthly. The BBC is a legally binding document that provides the current calculation of available credit and requires an officer’s signature attesting to its accuracy.
A standard BBC details the key figures needed to determine credit availability. It starts by listing the total amount of accounts receivable and inventory, then shows the subtractions for any ineligible assets to arrive at the eligible collateral totals. The certificate then applies the contractually agreed-upon advance rates to these eligible balances to calculate the borrowing base amount for that period.
This document is the primary tool for managing the line of credit, as the final number on the BBC dictates the credit limit until the next submission. If the company’s loan balance is below the borrowing base, it can draw more funds. If the balance exceeds a new, lower borrowing base, the company may need to pay down the loan to come into compliance.
Lender Monitoring and Adjustments
Lenders do not rely solely on the borrower-submitted BBC. They conduct periodic field exams or collateral audits to independently verify the information provided. These on-site audits can occur quarterly or annually, depending on the lender’s risk assessment and the loan agreement.
During a field exam, auditors test the A/R aging report by verifying invoices and confirming balances with customers. For inventory, they perform physical counts and test for obsolescence by reviewing sales and turnover data. The goal is to confirm the existence, value, and eligibility of the assets reported on the BBC.
The borrowing base is a dynamic figure. Based on audit findings, a lender may change eligibility criteria or adjust advance rates. If an audit uncovers discrepancies, such as a higher-than-reported level of delinquent receivables or obsolete inventory, the borrowing base will be reduced accordingly. Adjustments also occur due to normal business fluctuations, such as seasonal inventory changes or a major customer’s deteriorating creditworthiness.