Borrowing base: Overview, definition, and example
What is a borrowing base?
A borrowing base is the total value of a company's eligible assets that a lender considers when determining how much credit or financing the business can borrow. Lenders typically calculate the borrowing base as a percentage of qualifying assets, such as accounts receivable, inventory, or equipment, to ensure there is sufficient collateral for the loan.
For example, if a company has $1 million in accounts receivable and the lender applies an 80% advance rate, the borrowing base would be $800,000, meaning the company could borrow up to this amount.
Why is a borrowing base important?
A borrowing base is important because it helps businesses secure financing while providing lenders with a structured way to assess risk. By basing loan amounts on actual assets, businesses can access working capital without overextending their debt capacity.
For businesses, understanding their borrowing base allows them to manage cash flow effectively, ensuring they can finance operations, purchase inventory, or invest in growth while maintaining sufficient collateral for lenders.
Understanding a borrowing base through an example
Imagine a manufacturing company applies for a line of credit using its inventory and accounts receivable as collateral. The lender agrees to provide a loan based on 70% of receivables and 50% of inventory value. If the company has $500,000 in receivables and $300,000 in inventory, the borrowing base would be:
- Receivables: 70% of $500,000 = $350,000
- Inventory: 50% of $300,000 = $150,000
- Total Borrowing Base: $500,000
This means the company can borrow up to $500,000 under the agreed terms.
In another scenario, a retail business secures a revolving credit line based on its borrowing base, which fluctuates depending on inventory levels. As inventory value increases, the business can access more credit, while a decrease in inventory reduces the available borrowing amount.
An example of a borrowing base clause
Here’s how a borrowing base clause might appear in a loan agreement:
“The Borrowing Base shall be determined as the sum of (i) [X]% of eligible accounts receivable and (ii) [X]% of eligible inventory, subject to periodic valuation by the Lender. The maximum loan amount shall not exceed the Borrowing Base as calculated at the time of each advance.”
Conclusion
A borrowing base determines the amount of credit a business can access based on the value of its assets, helping companies secure financing while managing risk for lenders. Clearly defining the borrowing base in loan agreements ensures transparency, financial stability, and efficient use of credit.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.