By Andrew Dunn

What Collateral Examinations Reveal About Financial Reporting and Borrowing Base Integrity

We have noticed through our work with private credit firms that, as lenders, they continue to focus on borrowers’ processes to generate reliable information supporting lending decisions and not solely financial performance. This shift is particularly evident in financing structures supported by working capital assets such as accounts receivable and inventory. Asset-based lending (ABL) facilities are structured around the value of eligible collateral, most commonly accounts receivable and inventory. Eligible collateral may include current accounts receivable and inventory that satisfy the lender’s eligibility requirements, while aged receivables, disputed invoices, affiliate balances and obsolete inventory may be excluded from borrowing availability.  Unlike cash flow-based lending, borrowing availability is generally determined through a borrowing base calculation that applies advance rates and eligibility criteria to the underlying collateral pool. Because borrowing availability is directly tied to collateral quality, lenders rely on ongoing monitoring and periodic collateral examinations to validate the assets supporting the facility.

What is a Collateral Examination and What Does it Reveal

Collateral examinations are typically performed by accountants and involve a significant analysis of the underlying asset base supporting lending arrangements.  The procedures performed by the accountant in a collateral exam often include reconciling borrowing base inputs to underlying accounting records, testing accounts receivable aging reports, tracing cash receipts to customer invoices, evaluating customer concentration limits, identifying ineligible receivables, reviewing credit memo and dilution activity, and assessing the effectiveness of controls over accounting and borrowing base reporting. For inventory-backed facilities, procedures may also include testing inventory records, evaluating inventory turnover trends, and assessing potential obsolescence concerns. These detailed procedures provide a deep assessment of a borrower’s reporting environment, operational discipline, and financial controls.

While these procedures are designed to validate the accuracy of a borrower’s reporting on their collateral, they often reveal broader issues. For instance, the collateral exam can identify reporting gaps, inconsistent methodologies, weaknesses in internal controls, or insufficient documentation.  These issues can often go unnoticed absent a formal collateral exam, leaving the lender surprised upon notice of an event of default (EOD). 

Consider a facility with a reported borrowing base of $20 million consisting of accounts receivable. During the examination, the accountants identified $2.5 million of receivables aged beyond the eligibility threshold, approximately $1 million of customer concentrations exceeding limits established in the credit agreement, and several invoices subject to unresolved customer disputes.

While the borrower’s financial statements appear stable, the examination determined that certain receivables exceeded aging thresholds, were subject to customer disputes, or exceeded established concentration limits, rendering them ineligible under the terms of the credit agreement. As a result, the amount of eligible collateral, and therefore borrowing availability under the facility, was lower than previously reported.

More importantly, the collateral examination highlighted weaknesses in the processes used to monitor collateral eligibility and prepare borrowing base reporting. The issue was not simply a reduction in availability; it was a reminder that lenders evaluate both the quality of the collateral and the reliability of the financial processes supporting it.

Situations like this demonstrate why collateral examinations are often viewed as more than simple “check the box” compliance; rather, they are assessments of borrowing base integrity, reporting discipline, and financial credibility.

Collateral Examinations, Valuation, and Regulatory Scrutiny

Findings from collateral examinations can influence borrowing availability, but they may also provide important insight into valuation and reporting processes. SEC examination priorities have consistently emphasized valuation methodologies, governance, disclosures, and the documentation supporting reported values. For organizations operating within private credit and alternative investment structures, collateral examinations can provide an independent assessment of the data and controls that support both lender reporting and valuation conclusions.

What Prepared Organizations Do Differently

Organizations that consistently perform well under lender scrutiny typically maintain clearly defined eligibility policies, strong reconciliation processes, consistent borrowing base methodologies, reliable reporting controls, and organized supporting documentation. In an environment where verification carries greater weight than assumption, operational discipline becomes a competitive advantage.

How We Help

These challenges often become most visible during refinancing activities, growth initiatives, lender examinations, acquisition transactions, or periods of increased lender oversight. We work with private credit firms to strengthen the core drivers of collateral integrity, including borrowing base assessments, collateral eligibility framework evaluations, reporting process reviews, reconciliation assessments, examination readiness, and lender diligence support.

Closing Perspective

The growing focus on collateral examinations reflects a broader shift in credit markets: lenders increasingly want validation of underlying fundamentals and confidence in their borrowers’ ability to execute operationally, not just reported performance. Organizations that can support their borrowing base with accurate data, consistent processes, strong controls, and reliable documentation are better positioned to preserve lender confidence, maintain liquidity, and navigate capital decisions with greater flexibility.

For more information about Collateral Examinations, please contact Caroprese via e-mail to info@caroprese.com. 

About the Author

Andrew Dunn is the Head of Advisory Services at Caroprese & Company and a licensed CPA. He specializes in technical accounting, financial reporting, and strategic advisory services, helping clients navigate complex business and financial challenges.