Asset Based Finance: Proven Disciplines for Prudent Lending

By Gregory F. Udell

Published by Commercial Finance Association, 2004; ISBN 0-9667943-2-X

283 pages; $79.95 (hardcover)

Reviewed by Neville Grusd

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Prior to his academic career, the author, the Bank One Chair of Banking and Finance at the Kelley School of Business of Indiana University, was a commercial loan officer with asset-based lending experience at various banks.

Part I reviews asset-based financing and describes the asset-based lending philosophy in comparison to traditional commercial lending. Chapters 1 and 2 provide an excellent introduction to the subject, explaining clearly how asset-based financing works and when it is most beneficial. Chapters 3 and 4 address the structure of the asset-based industry and where it fits into the economy.

Part II, a detailed explanation of the process, includes how lenders analyze the borrower (Chapter 5) and the mechanics of lending against accounts receivable and inventory (Chapter 6). These chapters are essential reading. Understanding how an asset-based lender thinks is of great benefit.

Some important points are not covered in the text, but are referred to in the later case studies. These include lenders’ reliance on projections (which CPAs should be heavily involved in preparing), and their discretionary rights incorporated in the typical financing agreement.

Subsequent chapters in Part II deal with other aspects of secured lending, including a brief introduction to factoring; floor-plan financing; and lending against equipment. The final two chapters, dealing with borrower bankruptcy and organizational issues in the industry, are probably of less interest to accountants.

Part III comprises four case studies. These excellent presentations reinforce and expand the theory set forth in earlier chapters. The cases deal with financing a small firm; a mid-sized firm; and a distressed credit. Anyone interested in this topic should study these cases, which are well presented and contain much useful information. An additional case study on factoring supplements the earlier chapter on this type of financing.

Part IV includes special topics in asset-based finance. The first chapter in this section is on fraud, which is a very interesting topic for accountants. While written from the perspective of the lender—usually the victim of the fraud—the text and case studies will help accountants sharpen their audit techniques and internal controls to guard against this major problem. The last three chapters in this section—on creating and perfecting security interests in personal property; international asset-based lending; and key trends affecting the nature of transactions and structure of the industry—are probably of little interest to CPAs, although a current major development in asset-based lending is the size of transactions now being handled with this type of financing and the opportunities for creative financing for larger companies.

Another section deals with the limitations of financial statements for the lender’s purposes, particularly in the middle market. Accountants may well take exception to some statements in this section: for example, that smaller companies’ financials “are more often prepared by regional or local accounting firms, where professional talent, on average, is likely to be inferior to that found in big multinational firms”; reference to the “fundamental conflict of interest between accountants and their client that call into question the independence of any audit”; and “the inherent conflict that arises when accounting firms offer both consulting services and audit services.” Furthermore, the author says that in smaller firms “the outside accountant functions as a kind of de facto financial and strategic consultant … [which] surely challenges the objectivity of accountants who service the middle market.” This section ends with a statement that “these problems suggest a corollary to ‘know your borrower’; know your borrower’s accountant.”

In examining financial-statement fraud, the text covers the liability of accountants for failure to detect fraud and the lender’s legal recourse in such a case. While in certain cases accountants should not be isolated from liability for certifying financial statements in the face of growing evidence that results of operations are being manipulated, it’s heartening that the book quotes an attorney as saying that “any lender that makes a loan with the intention of suing the borrower’s independent certified public accounting firm to recover losses, deserves to lose.” Because of inherent limitations in financial statements and audits, asset-based lenders routinely conduct their own field exams, where they focus on the quality and performance of the collateral and prepare a defense against fraud on a continuous basis.