Meaning
Reductions applied to a borrowing base to exclude assets that do not meet specific quality, liquidity or legal criteria for collateralization. Lenders perform ineligible inventory deductions to ensure that only the most liquid and recoverable goods back a credit facility. These subtractions occur before the advance rate is applied to the remaining eligible pool.
Asset Quality
Stock that is damaged, obsolete or slow moving is removed from the borrowing capacity. Because ineligible inventory deductions target items that cannot be sold quickly in the open market, they protect the lender from overextending credit. Items held on consignment or stored at third party locations without a lien waiver are also excluded.
Exclusion Logic
Automated systems often flag inventory that has exceeded a certain age or has been returned by customers. These ineligible inventory deductions provide a real time view of the true collateral value. Changes in the exclusion criteria can significantly impact the amount of cash a borrower can access.
Recovery Probability
Raw materials generally face fewer deductions than work in process. Finished goods located in foreign jurisdictions may be subject to ineligible inventory deductions due to the complexity of local lien laws. The resulting net value represents the actual liquidation strength of the business.
