Benchmarking is a post appraisal tool to be used by relationship managers and credit managers to measure inventory NOLV based on changes in inventory levels, gross margins, mix, volumes, and operating expenses. Components of inventory value change so rapidly and frequently, lenders must monitor the adequacy of collateral on a frequent basis to ensure that advance rates correctly evidence the current inventory and operations. The tools in ARG reports are designed to give the Lender guidance as to the effect changes in inventory composition have on recovery. These changes are cumulative.

  • Varying Inventory Levels – As inventories decrease or increase, the net recovery will change in a direct relationship to the change in inventory. This happens because the change in inventory level will produce commensurately larger or smaller pools of gross recovery against which expenses are offset. Expenses do not fluctuate as much as inventory recoveries. This is shown on the following graph. Click on the graph for a larger image.
Varying Inventory hart
  • Varying Gross Margin % – Higher gross margins will typically produce higher gross recoveries. In an orderly liquidation, the price for which an item is liquidated is related to the price for which that item has recently been sold. If a company is experiencing declining gross margins, it is selling its product to customers at lower prices relative to the cost. This will be reflected in the liquidation recovery as in the following graph. Click on the graph for a larger image.
Varying gross Margin
  • Varying Finished Goods as a % of Total Inventory – Typically finished goods have a higher net recovery than other inventory components. They have been completed to the point of being readily salable to customers. As the percentage of finished goods to total inventory changes, the net recovery changes in a direct relationship as shown below. Click on the graph for a larger image.
Varying Finished Goods
  • Varying Top Producing SKU's as a % of Total – While ARG does not agree with the "80/20" rule (that 80% of the value will be produced by 20% of the inventory), the mix of the merchandise does directly affect the return in liquidation. ARG allows the lender to monitors the inventory mix by ranking the inventory at the SKU level by sales. When a significant percentage of the sales are accounted for at 80% or 90%, the inventory should be subtotaled and expressed as a percent of the total inventory. As this percent decreases, so will the recoveries as shown on the following graph. Click on the graph for a larger image.
Varying Top Producing SKU's

Cumulative Effect of Changes. It is extremely important to note that the effect of the above changes is cumulative. ARG has added notes, "Call ARG", on each graph, to indicate that a reappraisal of the inventory is prudent because that particular benchmark has deteriorated to the point that the collateral value is in jeopardy. These points are indicated at a level of decline for each benchmark that would result in a loss of net recovery of approximately 5%. However, if three benchmarks decline by 3% to 4% each, which would not independently cause concern, the cumulative effect would be a decline of 9% to 12% in the net recovery value of the inventory.
These benchmarks are estimates only and extrapolated from current data and, as such, not intended to replace periodic reappraisals. At each reappraisal the benchmarks will be reset to provide for the company's current operating experience.

Managing Risk with Benchmarking

The chart below shows the results of an inventory appraisal and the changes that have occurred 2 months later. Three of the benchmarks: Inventory, Gross Margin % and % of Finished Goods are easy to use as they are found on the Financial Statements and Inventory Certification. The mix of sales producing SKU’s must be calculated. ARG will provide the mechanics to do this to the Company or to the lender’s internal audit staff. Additionally, ARG will calculate this up to 2 times per year at no charge.

Chart 1

Each of the Benchmarks has a separate chart to calculate how much impact the changes above have had on NOLV. The use of Benchmarking Risk on the above changes show individual changes in the NOLV as below along with the cumulative change of a negative 9.25%

chart 2

If the user of the report does not use the Benchmarks, the loan will be nearly $3,000,000 over advanced. It must be emphasized that the Benchmarks are estimates only. They are to be used as a guide and trigger when additional steps might be warranted by the lender. Additionally, the client can make us of the Benchmarks when they are planning strategic changes. The Benchmarks will let them know in advance if the changes will affect their advance rates.

chart 3

Most of the Benchmarks can be tracked in less than 5 minutes every time a new inventory certification or financial statement is received. As said above, calculating the mix can take more time, but ARG will perform this as a free service two times per year or work with your staff to provide the tools to do it yourself.