Not receiving A/R from the customer timely, plus not having the A/R count towards your borrowing base can have a double-negative impact to cash flow. You may be surprised to find out that A/R you thought was included as an asset in your borrowing base, is actually excluded under the bank’s formula. However, letting A/R get beyond 60 days or more may make those assets ineligible for borrowing base purposes. This borrowing base typically sets the maximum credit available to a company. Some banks loan money based on a percentage of the value of a company’s assets pledged as collateral, which can include a company’s A/R.
Your company will be required to pay for all of these additional services and inspections, potentially putting great strain on your cash.įailing to manage your A/R can also reduce the available credit you have from your lender.
The lender could also require monthly inventory checks by an outside party, more frequent and reviewed or audited financial reports, outside valuations of equipment and assets, and even require you to hire an outside CFO. For example, your lender could increase the interest rate to the default rate, usually several percentage points higher than the normal rate. Once you default on a financial covenant, your lender normally has the right to impose all sorts of new costs and requirements on your business that will make cash flow even tighter. If you are lax in managing and enforcing your A/R, you may drift into default because of the FCCR. This covenant requires that your earnings or cash flow exceed your fixed charges by some ratio, usually starting from 1.15 to 1, to 2 to 1. A common financial covenant is the Fixed Charge Coverage Ratio (“FCCR”). There are several different financial covenants and tests that your lender may use in your loan agreement. It’s critical to understand how managing your accounts receivable (“A/R”), for example, can impact your cash flow and your available credit and lending costs with your lender.Įven if you’re paying your loan payments on time, your lender may send you a default notice because your company has violated certain financial covenants in your loan agreement. Managing cash flow can be challenging for many business owners in the current economic climate.
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