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Don't Be Scared Off From Receivables-Based Financing

July 1, 2003
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Despite a recent accounts-receivable "scandal", securing credit based on outstanding receivables remains the best approach for some businesses BY KEITH D. REUBEN AND PATRICK L. COFFEY

Recent negative headlines shouldn't deter you from using this valuable capitol reource BY KEITH D. REUBEN AND PATRICK L. COFFEY In the wake of National Century Financial Enterprises' (NCFE) well-publicized bankruptcy in late 2002, some nursing home operators might now be thinking twice about securing credit based on their outstanding receivables. Although understandable, such hesitancy could be a costly mistake for two reasons:
    1. Cash flow liquidity is the lifeblood of any business, particularly those that can recognize and seize opportunities during an economic downturn; and
    2. This type of knee-jerk reaction fails to distinguish between two distinct lending models: accounts receivable (A/R) financing and factoring. They are as different as night and day.

In fact, A/R financing from an established lender that understands the unique challenges of operating nursing homes often is the only way to overcome the "reimbursement blues" caused by slow, inconsistent payers. If your business needs a reliable source of capital to cover fixed costs, expand, or insure against slow payers, considering potential A/R financing solutions should be high on your list of priorities.

This article will explore why A/R financing is a viable option, examine how A/R lenders evaluate your creditworthiness, and show other ways you might benefit from this type of financing.

Rationale for A/R Loans and How They Work
Businesses use A/R financing primarily to meet short-term cash flow needs. A vast majority of nursing homes in the United States finance their accounts receivable. The following hypothetical example shows why this form of credit is so popular in this industry:

ABC Nursing Home is a profitable nursing facility that receives the majority of its reimbursement from Medicare and Medicaid. Although these government programs pay their bills consistently, payments usually lag invoices by 30 to 60 days. ABC's commercial insurance payers take even longer to make payments. Because of its unpredictable monthly cash flow, ABC Nursing Home often cannot satisfy ongoing financial obligations (e.g., payroll, food, rent, etc.) in a timely manner. To ensure that it continues to operate successfully, ABC must accelerate the rate at which it monetizes its government and commercial receivables. A receivables line of credit, which provides immediate cash and liquidity, enables ABC to meet its monthly obligations.

Nursing homes have generally obtained this credit from two types of commercial finance firms. Factoring companies purchase the receivables with minimal concern as to the ongoing viability of the nursing home business. NCFE, until its bankruptcy, was the nation's largest purchaser of hospital, physician, and other healthcare receivables. NCFE would buy the receivables, then pool and sell them in the form of asset-backed securities to institutional investors as a way to access less expensive capital.

Most receivables credit lines in this industry, however, come from traditional A/R lenders; their credit lines are based on simple formulas related to the receivables' age. The older the account, the less likely it will be paid and the less value it has in the eyes of the financier. Generally, A/R financing companies will lend an amount equal to 85% of the net receivables of nursing home operators, up to 180 days past due. The vast majority of these receivables are from Medicare, Medicaid, and commercial insurance companies. As these receivables are monetized and new receivables generated, nursing homes create additional collateral to include in their borrowing base (see below). The dynamics of this process give A/R lenders an increasingly vested interest in the credit and ongoing viability of the nursing home operator.

Lender's Due Diligence Considerations
Before committing to a line of credit, the A/R lender will perform due diligence to determine the amount of the loan, as well as the financial stability of the nursing home operator. This due diligence will focus on (1) confirming the potential borrower's accounts receivable, (2) analyzing third-party payers/reviewing regulatory compliance, and (3) performing financial analysis of operations. Confirming accounts receivable. The primary purpose of this review is to determine that the quality/quantity of the collateral is sufficient to support the amount advanced (also referred to as the "borrowing base"). Before applying the appropriate advance rate (typically 85%), the A/R lender will eliminate certain ineligible items from the base, including contractual reserves, aged receivables (i.e., those held beyond the eligibility period, typically 120 to 180 days), and private copay receivables. Since some receivables may fall into more than one ineligible category, make certain that your A/R lender takes extreme care to ensure these are deemed ineligible only once so as to not unduly limit your borrowing base.