DEFINITION of ‘Overadvance’
An overadvance describes a short-term commercial loan taken by a company to purchase more materials for its inventory in preparation for an expected period of increased sales. An overadvance is used to build inventory before a peak sales period. The key feature of an “overadvance” is that the loan amount taken out by the company temporarily exceeds its (borrower’s) accounts receivables; the loans are generally commercial and are usually short-term ranging from 30 days to one year.
BREAKING DOWN ‘Overadvance’
For example, a company may expect increased sales of product ABC during the upcoming holiday season. The company does not have enough product to cover the expected demand for this period. To meet the anticipated demand, the company must purchase or manufacture additional products to increase the inventory, and can do so with an overadvance.
The idea of overadvance credit falls into the hybrid or specialty finance category. Often, for companies seeking maximum financial leverage, such as many middle-market businesses, asset-based loans paired with a cash flow component (which constitutes the overadvance piece) make an attractive hybrid financing alternative. Here, companies get the borrowing base leverage of an asset-based structure with the flexibility of a cash-flow solution. The overadvance is not covered by the availability of funds provided by assets. Instead, a lender or creditor evaluates a company’s historical cash flow and availability to repay any debt. Asset-based loan structures combined with an overadvance are an excellent choice for asset-intensive acquisitions, such as those common with manufacturers, wholesale distributors and retailers. Typically, these old economy businesses are capital intensive, yet have lower gross profit margins.
For cyclical businesses, seasonal overadvance can make a smart financing structure. Variable working capital needs can often be addressed with debt structures offering flexibility for the many expansionary and contractionary twist of the business cycle.