When Businesses have borrowed money from a Bank or any other Financial Institute based on their Assets – usually AR and Inventory, they will be subject to a “collateral audit” as a condition of the loan. This is done by a CPA and is usually limited in scope, as their examination is primarily the businesses current assets. The Bank has lent money against your assets; they want to check the quality and accuracy of their collateral, which is constantly moving and changing.
When you borrow money, a firm should establish accepted accounting principles and be following them consistently – GAAP. What this means is, in the context of a collateral review is:

1. Have genuine Sales – Do not raise tentative invoices that will subsequently be cancelled. Your invoices should have a contract or Purchase Order, a proof of delivery and acceptance.
2. Have a regular sales cycle – a calendar month is normal. Do not invoice 2 or 3 days into the next month and pull these sales into the current month. Do not have a sales cycle where one month is 35 days and the next is 25 days.
3. Do not “refresh you Invoices”. That is, as they get older than 90 days, do not re-date them to show a current date.
4. Match collections to individual invoices.
5. Keep a good record of adjustments, write-offs and Bad debts. You will be asked to explain.
6. Do not write off a debt and then reintroduce it with a new date.
7. Your delivery, invoicing and collections should show a good paper trail and relevant staff trained in what the Bank wants to see.
8. Store and record Inventory in an easily verifiable manner.
9. Value Inventory – Receipts and Issues in a consistent method and manner. Adopt FIFO, LIFO or average cost and do not change this method mid-year.
10. Take a physical count and match it to your records.

In preparing for an audit; get a list of documents that the CPA will need to see, in advance. Usually, this will be the Financials – P&L and Balance Sheet, Aging reports – AR and AP, Inventory movement reports. Also, they will ask for samples of invoices, bank deposits, Inventory receipts and issues and Bad debt write-offs. The collateral audit should be handled in 3 stages:

1. Assemble and send them the documentation in advance.
2. When they visit- dedicate staff to work with them
3. Answer all questions when they visit. At this stage, more documents and verification will be needed; do this as a priority.

I have done collateral audits that went from four days to one day and the frequency of the audit being reduced to twice a year compared to four times a year. All this saves money and improves the lenders’ confidence.