Lenders advance against inventory on what it would fetch in an orderly liquidation, not on what it cost. Inventory typically advances at up to 85% of net orderly liquidation value, which usually works out to roughly half of cost. Finished goods that many buyers want advance best, raw materials that are commodities come next, and work-in-process rarely counts at all. Slow-moving, obsolete, consigned and in-transit stock is excluded, and most agreements add a sublimit capping how much of the borrowing base inventory can supply.
- Advance basis
- Net orderly liquidation value, from an independent appraisal
- Typical advance
- Up to 85% of net orderly liquidation value, roughly half of cost
- Advances best
- Finished goods with a broad market; commodity raw materials
- Rarely counts
- Work-in-process, packaging, supplies, customer-specific goods
- The usual cap
- An inventory sublimit, as a fixed amount or a share of the base
Why lenders use liquidation value, not cost
Cost tells a lender what you paid. It does not tell it what someone else would pay if the lender had to sell the stock without you. That is the only number that protects an asset-based lender, so inventory advances are set on net orderly liquidation value (NOLV): the price the inventory would bring in a sale conducted over a reasonable period, by a professional liquidator, net of the costs of the sale.
Those costs are real and they add up: the liquidator's commission, the payroll to run the warehouse during the sale, rent and utilities, freight to buyers, and the discount buyers demand for stock sold in bulk with no warranty and no ongoing relationship. The appraisal estimates recovery category by category, and the lender then applies an advance rate to that recovery. Inventory typically advances at up to 85% of NOLV, which leaves the lender a margin for error in the appraisal itself.
The result, for many businesses, is an advance of roughly half of cost. That is not a judgement on your inventory. It is the arithmetic of two haircuts in a row: one for what a stranger would pay, and one for the uncertainty of that estimate. How the result fits into the rest of the facility is covered in how a borrowing base works.
Raw materials, work-in-process and finished goods
| Inventory class | How lenders see it | Usual treatment |
|---|---|---|
| Finished goods, broad market | Saleable as is to many buyers, often through existing channels | Best advance; the core of most inventory availability |
| Finished goods, customer-specific or private label | Saleable to one buyer, or only after relabeling | Lower recovery, sometimes excluded |
| Raw materials, commodity | Steel, lumber, resin and similar goods with active resale markets | Good recovery, often close to finished goods |
| Raw materials, specialized | Components made to your specification | Low recovery; often a reduced rate or excluded |
| Work-in-process | Partly made goods that cannot be sold as they are and cost money to finish | Usually excluded; occasionally advanced at a nominal rate |
| Packaging, labels, supplies | Little value to anyone but you | Excluded |
| Slow-moving and obsolete | Stock without recent sales or past its useful life | Excluded, using an aging or turnover test |
| In transit, consigned, off-site | Goods the lender cannot reach, or does not have a clear lien on | Excluded unless documents and waivers give the lender control |
The pattern is consistent: the closer a unit is to something a stranger can buy and use, the more a lender will advance against it. Commodity raw materials often recover well because they have a market price and many buyers. Specialized components recover badly because only you want them.
Why work-in-process rarely counts
Work-in-process is the category owners argue about most and win least. Partly assembled goods usually cannot be sold in their current state. To realize value, the lender would have to finish them, which means keeping the plant running, paying staff and buying the remaining materials, all while the business is failing. Or it would sell them as scrap or to a competitor at a fraction of their cost. Neither is a position a lender wants to rely on.
The practical consequence is that manufacturers with long production cycles get less inventory availability than their balance sheets suggest. A business that carries a large share of its inventory as work-in-process should size its line on receivables and finished goods, and treat any WIP advance as a bonus. Shortening the production cycle has a direct effect on availability. Reclassifying goods as finished before they are does not: the appraiser tests the categories against the floor, and a misstated inventory report is a misstated certificate.
The appraisal, and what moves it
An inventory appraisal is done by an independent firm the lender engages, at the borrower's cost, before closing and periodically after. The appraiser visits the locations, reviews sales history and margins by category, tests the perpetual records against counts, and studies how similar goods sell in liquidation. The output is a recovery estimate, usually expressed as a share of cost, for each category.
Factors that raise recovery:
- Healthy gross margins, which suggest the goods sell well above cost in the ordinary course
- Fast turnover and little aged stock
- A broad customer base for the product, not one or two buyers
- Accurate perpetual inventory records that match physical counts
- Stock held in owned or controlled locations, with landlord or warehouse waivers where it is not
Factors that lower it: perishable, seasonal or fashion goods; technology with short product lives; heavy customer-specific content; poor records; and large quantities of any one item relative to its market. Because the advance rate is applied to the appraised value, the appraisal usually moves availability more than any argument over the advance rate does.
Sublimits, and a worked example
Most asset-based lenders do not let inventory carry the whole borrowing base, because receivables turn into cash on their own and inventory does not. They cap the inventory contribution with a sublimit, either a fixed amount or a limit tied to the rest of the base, such as not more than the receivables availability. Some also advance on the lower of a share of cost and 85% of NOLV, so a strong appraisal cannot push the advance above a set level.
Take a manufacturer with inventory at cost of 4,000 (in thousands): 2,200 of finished goods, 1,000 of raw materials, 500 of work-in-process, 200 of slow-moving stock and 100 in transit.
| Step | Amount | Note |
|---|---|---|
| Inventory at cost | 4,000 | Per the perpetual records, reconciled to the ledger |
| Less: work-in-process | (500) | Excluded |
| Less: slow-moving and obsolete | (200) | No sales in the look-back period |
| Less: in transit | (100) | No control documents |
| Eligible inventory at cost | 3,200 | Finished goods and raw materials |
| Appraised net orderly liquidation value | 1,900 | The appraiser's recovery, category by category |
| Advance at 85% of that value | 1,615 | Roughly half of eligible cost |
| Sublimit | 1,200 | The agreement caps inventory at 1,200 |
| Inventory availability | 1,200 | The lower of the advance and the sublimit |
Inventory of 4,000 at cost contributes 1,200 to the base. Here the sublimit, not the appraisal, is the binding constraint, which is useful to know: improving recovery would add nothing, but negotiating a larger sublimit, or growing receivables availability where the sublimit is tied to it, would.
Find the binding constraint first. If the sublimit binds, a better appraisal adds nothing; if the appraisal binds, cleaning up stock does.
Reporting, controls and how to improve availability
Inventory in a borrowing base comes with reporting. Transparent's line of credit checklist includes an inventory report whenever inventory is part of the base, alongside the receivables and payables agings, balance sheet, P&L and debt schedule. Lenders expect that report by location and category, reconciled to the general ledger, backed by a perpetual system with regular cycle counts and at least an annual physical count.
The steps that most often raise inventory availability before a lender sees the file:
- Write down or dispose of obsolete stock, so it does not drag down the appraisal of everything else
- Get landlord and warehouse waivers signed, to avoid rent reserves or exclusions
- Separate consigned goods and customer-owned stock in the records
- Bring perpetual records and physical counts into line before the appraiser arrives
- Understand whether the sublimit or the appraisal binds, and negotiate the one that does
Inventory-heavy businesses often find that an asset-based line still beats the alternative, because a cash-flow line sized on thin distribution margins is smaller still. The receivables side of the base, usually the larger one, is covered in eligible vs ineligible receivables. Of the lenders in Transparent's book, 235 write asset-based loans and lines, and their appetite for inventory varies widely: some advance on it readily, some only as a small part of a receivables-led base.
Common questions
- What is net orderly liquidation value?
- The amount inventory would bring in a professionally run sale over a reasonable period, after the costs of the sale. It is estimated by an independent appraiser and is almost always well below cost.
- Why is my inventory advance so much lower than my receivables advance?
- Receivables turn into cash when customers pay. Inventory has to be sold first, at a discount and at a cost. Inventory typically advances at up to 85% of net orderly liquidation value, roughly half of cost, against typically 80% to 90% of eligible receivables.
- Will a lender advance against work-in-process?
- Rarely. Partly finished goods usually cannot be sold without being completed, which a lender does not want to fund. Some lenders allow a small advance on specific WIP, but most exclude it.
- How often is inventory appraised?
- Before closing, and then periodically at the lender's discretion within limits set in the agreement, usually at the borrower's cost. Appraisals tend to become more frequent when availability is tight.
- What is an inventory sublimit?
- A cap on how much of the borrowing base inventory can supply, set as a fixed amount or relative to the rest of the base. It keeps a line from depending too heavily on the collateral that is slowest to turn into cash.