I was at a new client last week and saw a rather unusual calculation on the line of credit availability.  I checked with a banker afterwards.  He said his bank and most others don't do the calculation that way, but that he had heard of a few banks using it in special circumstances.

 

What was unusual- it was the accounts receivable availability.

 

In this case, the bank subtracted the accounts payable balance from the receivables balance.  That net amount was what the client could use to borrow against the line of credit.

 

That is very different than the typical arrangement, where the entire accounts receivable balance (less any excluded accounts such as old invoices over 120 days) and then a percentage used, such as 75 or 80%, to calculate what the company can borrow on its line based on receivables (this does not include inventory which is often included as well).

 

The difference can be very huge.  It could mean that you don't really get to borrow much on your line of credit.  Consider the following example:

 

Typical AR Availability
AR Balance	1,000,000
Availability	75%
Line of Credit Availability	750,000
Unusual Alternative
AR Balance	1,000,000
AP Balance	800,000
Line of Credit Availability	200,000

 

 

In the above example, the company would have $550,000 less in borrowing power.

 

This second calculation is very conservative.  I understand it may be used in some industries like construction where the bank wants to keep a close watch on the net working capital and make sure the money is going to pay off payables. 

 

However, normally a bank has a preferred position with the receivables, so their claim would come ahead of regular payables.  I think the deduction of AP is very conservative.  The bank is protected without it.

 

If your bank takes off AP from your borrowing base for your line of credit, perhaps it is time to get your banker to change the formula.  Otherwise, take a look for another bank.