Reactivating the payment chain post-Covid-19

April 2021

Warren Buffet famously said, “Cash is to businesses what oxygen is to people”. Today, this encapsulates the concerns of SME owners feeling the effects of broken payment chains caused by restrictions introduced by governments to mitigate against Covid-19.

While several governments have introduced financial support initiatives to soften the blow, in many cases these have failed to reach some businesses.  Reasons include a lack of charge-free assets available as security for Covid loans without state guarantees to secure the portion of the Covid loans not guaranteed by the State. The dearth of accounting records attaching to some small businesses, often amounting to no more than some bank statements and a list of receivables, is another reason for this failure.

Asset-based loans

There is a tool, widely used in North America, that could be useful to SMEs looking to free up payment chains. This tool is known as an asset-based loan (ABL) and amounts to a loan against current assets. An ABL is a revolving credit facility that uses the borrower’s receivables and inventory simultaneously as a primary and secondary source of repayment. The book-value of these assets supports the advance made by a lender while their collection (or sale and collection) generate the cash flows for repayment of the loan.


A manufacturing business has been disrupted by Covid-19 restrictions. When the clients of the business were also affected by Covid-19, the business used all its available cash to cover payroll, utilities, and certain suppliers. When restrictions were lifted allowing the business to resume operations, it found itself with insufficient cash to reopen and restart production.

The business has inventories with a book value of $100,000 including raw materials and finished products, and accounts receivable amounting to $60,000. An ABL allows a lender to advance up to 50% of the value of its inventories and up to 75% of its accounts receivable. In this example, a loan of up to $95,000 ($50,000 + $45,000) might be available. As the business has now monetised its account receivables and inventories to get the loan, its ability to create further debt by again drawing funds up to its maximum credit line is reduced, pending paydowns. This cycle of reporting balances and determining the maximum amount of the revolving credit line is repeated every 30 days, or more frequently for high-risk borrowers. As a protective measure, the lender uses an audit firm to verify, every six months, the accounting balances reported by borrowers.

Asset-based loans offer advantages for both borrowers and lenders. The borrower acquires the resources necessary to run the business without needing to offer up property or financial assets to a lender as security. In turn, the lender can assess its risk and exposure objectively while taking a charge against monetised assets. The safety margin created by only lending against a proportion of the assets gives the lender relative certainty of recovery. In Peru, legislation governing the pledge of current assets requires a designated trustee or custodian of those assets. This role carries civil and criminal responsibilities.

Although the initial and ongoing audit of the pledged assets is an expense for the borrower, this is usually offset by the lower interest rate that lenders tend to charge given their relative certainty of recovery.

For ease of explanation, I’ve presented a simplified view of how ABLs work. However, they do require the involvement of an experienced audit firm. As well as the formal documentation needed at outset, a valuation of the assets needs to take place. This requires a detailed audit of the accounts receivable to verify that they are supported by corresponding customer orders, as well as corresponding shipping and delivery documents. Likewise, the nature, condition, and rotation of the inventories require careful examination. Only after these audits can a lender determine how much it is willing to lend – the borrowing base.

In conclusion, ABLs as a tool for lenders and borrowers are potentially useful in the current environment. Obviously, this method of credit requires the support and agreement of local financial authorities. In Peru, despite the favourable legal framework surrounding the pledge of current assets, banking regulations only recognise as preferred collateral the inventory held in custody by bonded warehouses, pledged with the support of warrants. It is up to other countries to develop their own rules.

About the author

Jesús Fernando De la Torre
Lima, Peru

Fernando is a corporate finance and international banking professional at Russell Bedford Perú. He has over 25 years of experience working in US, Canada, Panama and Peru, in the areas of credit risk management, troubled-debt recovery, and structured trade finance. He holds a BSc degree in Business Administration from Universidad del Pacífico in Lima-Peru, and an MBA degree from Loyola University in Chicago, IL. His current focus is in GRC and ESG with a special interest in COSO´s ERM and Internal Control Frameworks, as well as ISO´s Corporate Governance, Risk Management and Antibribery Standards.

Author: Jesús Fernando - Russell Bedford Perú, De la Torre Lima, Peru

The Russell Bedford website employs cookies to improve your user experience. We have updated our cookie policy to reflect changes in the law on cookies and tracking technologies used on websites. If you continue on this website, you will be providing your consent to our use of cookies.

Find out more
I accept