Borrowing Base

A borrowing base refers to the maximum cap on the loan amount that the lender can sanction to a borrower firm on the basis of the latter's pledged collateral. Most firms utilize this loan to fund their projects, expand their existing business, pay back their debtors, and increase their customer base for more revenues.

Many lenders use borrowing bases as a tool to evaluate the sum amount to be lent to borrowers, making their collateral a base for the loan. No lender provides a full collateral value as the loan amount and includes a discount factor, making it equal to the borrowing base. They net the value of all collateral and subtract it from the overdue credit to find the loan amount. 

• A borrowing base is the maximum loan quantity that a lender may grant to a borrower company in consideration of the offered collateral.
• The majority of businesses use this loan to finance initiatives, grow their current business, pay off debts, and attract additional clients to generate more income. Many lenders utilize the borrowing base as a tool when determining how much money should be provided to borrowers as security.
• It is calculated as the sum of a certain percentage of assets and a certain percentage of a firm's accounts receivables.
• It is a percentage of total assets plus accounts receivables of a borrower decided by the lender, whereas the advanced rate is the maximum permissible loan amount made available to the borrower by the lender.

A borrowing base is the total amount that a lender decides to grant to the firm as a loan using the method of margining. A borrowing base lends a cushion to the financial security of a banking institution as they can back their credit with assets that help recover the loans in case of defaults.

The borrowing base is directly related to the value of the collateral a borrower provides as its value fluctuates with the market. If the value of collateral decreases, then the borrowing base decreases and vice versa. As a result, the lenders increase the loan amount with the rise in the value of the collateral and vice versa. 

A borrowing base helps lenders safeguard their capital and provides an opportunity for business growth. All the firms get revolving credit from their banks for trading like stock purchase plus storage, transportation of manufactured goods, and selling their products. A usual tenure of revolving credit has been two years for every firm applying for loans and sanctioned by lenders on the basis of borrowing base. 

A lender sanctions the revolving credit to businesses for cash advance facility and uses it for trading as an instrument facility. A lender calculates the borrowing base of a borrowing firm as follows:

• They determine the values of the borrower's inventory.
• They evaluate the value of a firm’s equipment.
• They assess the total value of accounts receivables of a firm. 
• Then, they apply their advance rate.

After they have calculated the total limit of the loan amount using the margining technique, the lenders create a borrowing base certificate after meticulous calculation utilizing the total assets and accounts receivables. Once a lender has sanctioned a loan, they ask the borrowers to update the certificate at regular intervals. 

A bank has its criteria for calculating borrowing base facility for firms. They use the technique of margining to do that. Margining is a certain percentage discount on the total value of collateral plus the accounts receivables.

Let us calculate the borrowing base with this in our mind.

Let there be the total value of ones:

inventory assets and equipment as collateral = C

accounts receivables = A

Let the bank have the discount percent of:

• x% on C
• y% on A

Therefore, the borrowing base of the bank would be:

B = x% on C + y% on A

Let us understand the topic using a few examples.

Example #1

Let us take a firm XYZ corporation that manufactures pistons and sells them. It applies for a loan in its bank for 200000 dollars. It has the following:

Accounts receivable = $200,000 

Inventory of finished goods = $50,000

However, the bank allows loans on the following:

Accounts receivable = 75% of its value

Inventory of finished goods = 50% of its value

Therefore, the bank of XYZ corporation will give it a loan amount of:

75% accounts receivable + 50% of the inventory of finished goods

Or, loan amount = 75%*$200,000 + 50% * $50,000

                          = $150000 + $25000

Hence, the borrowing base finance for the corporation against its accounts receivables and inventory as collateral comes out to be = $175,000 

Example #2

A consortium of eight banks representing the agricultural commodities firm Transoil in Eastern Europe has extended its borrowing base credit to $200 million. This agreement, signed on June 30, also empowers Transoil to procure products from the 2023 harvest in Romania and Moldova. 

Furthermore, the facility includes OTP Bank Moldova as one of the lenders and ING as the primary facilitator and security agent. Thus, this funding will play a pivotal role in supporting Transoil's operations and global expansion in the competitive marketplace for agricultural commodities. 

With its specialization in grains and oilseeds, Transoil operates state-of-the-art manufacturing and storage facilities in Romania, Moldova, and Serbia. It also engages in extensive trade across various locations.

Let us use the table below to understand the difference between the two:

This has been a guide to what is Borrowing Bas. Here, we explain its calculations, examples, and comparison with the advanced rate. You can learn more about it from the following articles –

• Consumption-Based Capital Asset Pricing Model
• Borrowing Capacity
• Asset Based Lending