A contract manufacturer’s balance sheet shows $1.6M of inventory and the owner reasonably expects to borrow against it. The borrowing base gives credit for less than a third, because the largest component, work in process, is worth nothing to a lender and the reason is uncomfortable but sound.
Why is work in process excluded from a borrowing base?
Because a half-finished part has no market. Raw material can be sold back into a commodity or trade market. Finished goods can be sold to someone, at a discount. A casting that has been through three of seven operations, cut to a customer’s drawing, is scrap to everyone except the customer who ordered it, and that customer has no obligation to buy it.
Advance rates reflect what an asset converts to in a liquidation, which is the logic set out in inventory financing and, for machinery, in forced liquidation value. Applied to WIP, the honest answer is usually zero.
A worked example
A job shop with $8,000,000 of revenue:
| Inventory category | Book value | Advance rate | Availability |
|---|---|---|---|
| Raw material | $500,000 | 50% | $250,000 |
| Work in process | $800,000 | 0% | $0 |
| Finished goods | $300,000 | 60% | $180,000 |
| Total inventory | $1,600,000 | $430,000 |
Availability of $430,000 against $1,600,000 of inventory is 27 cents on the book dollar, and half the balance sheet value produced nothing at all.
Add eligible receivables of $1,300,000 at an 85% advance rate, or $1,105,000, and the facility supports roughly $1,535,000. That is the real number, and it is worth knowing before a shop commits to a large long-lead job.
Why does this bite job shops specifically?
Because their business model concentrates value in exactly the excluded category. A long-cycle shop running six to twelve week jobs holds a large WIP balance permanently, and the more complex the work, the higher the proportion of value that sits in the one bucket a lender ignores.
It is the inverse of a distributor, whose inventory is entirely resaleable and whose borrowing base tracks its balance sheet closely.
What can a manufacturer actually do about it?
Five options, roughly in order of how much they help.
- Progress billing. Negotiate milestone invoicing so the work converts to a receivable before the part is finished. This is the single most effective change, and it moves value out of a 0% category into an 85% one. The construction version of this billing structure is covered in construction financing.
- Customer deposits on long-lead work. Cash up front, which finances the job directly and signals commitment.
- Customer-supplied material on large jobs, which removes the raw material purchase from your balance sheet entirely.
- Purchase order financing for the material buy on a specific large order, which is sized off the order rather than the balance sheet.
- An equipment facility sized off the machine base, kept separate from the working capital line.
Does anyone lend against WIP?
Occasionally, at low advance rates, and only under specific conditions: a firm non-cancellable order from a creditworthy customer, a short remaining cycle, standardised rather than bespoke output, and a cost accounting system the examiner can actually test.
The last condition eliminates most applicants. A shop that cannot demonstrate accurate job costing has no way to prove what the WIP balance represents, and an examiner who cannot verify it will not advance against it. What that testing looks like is in the ABL field exam.
What does good job costing get you?
More than an advance rate. A shop with reliable per-job costing knows its true margin by customer and by part number, which changes quoting, and it can produce the evidence that supports every other request it makes of a lender.
In practice the shops that get the best terms are not the ones with the newest equipment. They are the ones whose numbers can be checked.
How should a shop plan a large order?
Model the cash before accepting it. Material purchase, labour through the build cycle, and the gap to the first invoice, against available borrowing capacity. A $2M order at a healthy margin can still be the thing that breaks the company if the cash requirement peaks above the facility in month two.
That is the same failure mode described in staffing agency financing, arriving through a different door: the win is a cash event before it is a profit event.
The short version
Work in process is where a job shop’s value sits and where a borrowing base gives no credit, so inventory that looks substantial supports very little. The fixes are commercial rather than financial: progress billing, deposits, customer-supplied material, and job costing good enough that an examiner can verify what you say you have.