Accounts Receivable Inventory Finance is a fundamental form of commercial lending that is collateral based. This type of financing combines elements of short term business loans with secured lending. In the purest form a commercial borrower will use the value of their receivables and their working assets or inventory as collateral to secure financing as a way to produce and market their services and products. Financing is repaid when the inventory is converted to cash. This is done either from direct sales or through collecting accounts receivable notices. Depending on the borrower’s risk profile, the lender will exercise different degrees of control over collateral in order to minimize the risk of the transaction.
There have been many variations of ARIF developed over the years. There are some forms of ARIF that will include assets other than inventory and receivables. In addition, the controls over the collateral have been changed and repayment sources are expanded to not only include the conversion of working assets.
This type of loan used to only provide funds to finance inventory, but now can be used for financing acquisitions, restructuring debt, and to hold companies through times of distress. Service organizations, importers, retailers, distributors, wholesalers, and manufacturers all use Accounts receivable inventory finance to meet the needs of their business. While there have been several changes made to this form of financing, it still remains one of the most essential ways for a borrower to leverage their assets in order to get financing.
Why Use Accounts Receivable Inventory Finance?
Many ARIF relationships have a moderate to high risk. A borrower will turn to this type of financing when they are unable to get another type of financing. Borrowers using this type of financing are typically not as financially strong as another commercial borrower. There are some reasons for this, perhaps their company operates in an industry where there is significant seasonality or has a high volatility. Some companies are experiencing a rapid growth and need the money quickly. This type of borrower exhibits a higher risk of default characteristics including:
- High leverage
- Marginal profitability
- Limited cash reserves
- Limited working capital
- Collateral pools that are constantly changing and whose value could fall quickly.
ARIF transactions that are properly structured will limit the risk of default by imposing certain controls on both cash and collateral of the company that has borrowed the money. When the loan is margined properly and prudent control processes and monitoring is applied by the bank, the risk of loss can be less than some of the other types of commercial lending that is available. The key is to minimize the risk. When a borrower poses a significant amount of risk, the lender will need to implement more control over the loan. Lenders have to have a large amount of management expertise including a great understanding of the business that the borrower is in and good reporting systems. In addition, the lender must keep ongoing supervision of the relationship and collateral of the borrower.
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