Meaning
Standard clause in asset based lending that prevents unfinished goods from being counted toward the borrowing base. Lender preference focuses on collateral that can be easily sold in the event of a liquidation. The work in process exclusion reduces the amount of credit available by removing the value of items currently on the production floor.
Policy implementation ensures that the loan is backed by finished inventory with a known market price.
Inventory Assessment
Classifying assets according to their stage of completion is a requirement for modern accounting. A work in process exclusion requires a clear distinction between raw materials, goods in production, labor costs and finished products. Lenders only want to lend against items that are ready for immediate shipment to a customer.
This distinction protects the bank from the risk of owning half finished products that have no value.
Valuation Discount
Excluding partially completed items results in a more conservative borrowing limit. The work in process exclusion acts as a buffer against the costs and the difficulties of finishing products after a business failure. Because the lender cannot easily sell a partially assembled machine or a half sewn garment, these items are assigned zero value.
The approach forces the borrower to manage their production cycle efficiently to maximize their credit access.
Eligibility Standard
Maintaining a high borrowing base requires a focus on moving inventory quickly through the factory. The work in process exclusion encourages management to minimize the time goods spend in the production phase. Only assets that meet the strict definition of eligible inventory are included in the calculation.
Regular audits verify that the company is correctly categorizing its assets.
