What You Don’t Know About Your Borrower’s Fixed Asset Maintenance Policies Can Hurt You

By Freed Maxick ABL on October 1, 2013
Back to main Blog
Freed Maxick ABL

Authors: John Costello                    

Skimping on Repairs and Maintenance Can Put Your Asset Based Loan at Risk

As you know, fixed assets are often pledged as loan collateral. Because of this, lenders have a vested interest in making sure these assets are adequately maintained. To ensure this, ask clients about their fixed asset maintenance policies, and tour their facilities to get a first-hand look at how they keep house.

Keep everything running smoothly

Businesses may be tempted to put off repairs and maintenance work when cash is tight. But this strategy can be costly. For instance, regular oil changes are a really small price to pay because they can prevent a machine’s engine from seizing up and needing to be rebuilt.Furthermore, adhering to a regular maintenance schedule is just as important for professional services firms as it is for manufacturers and retailers. All types of companies should update and replace software and computers regularly. If they don’t, productivity will be impaired.

Maintaining fixed assets

Be sure to create a printout of the fixed asset register. Clients should not only record the location and condition of each asset, but also tag each asset with an identification number. Companies may quickly discover that some items on the register are missing or broken and, therefore, should be repaired, replaced or written off.When tracking down fixed assets, you need to not only look at equipment and furniture, but also real property assets such as HVAC systems, elevators, drainage systems, foundations, interior and exterior painting, and windows. And borrowers who rent their facilities may have leasehold improvements that will require maintenance.

Developing a schedule

The next step is for the business to create a formal repairs and maintenance schedule. The schedule should describe every asset in detail, such as:
  • The name of the manufacturer,
  • Standard operating procedures,
  • Location of the operating manual, and
  • Warranty details.
Some repairs may already be covered by the equipment’s manufacturer. So make sure your borrowers are reviewing the warranties before approving a purchase order for repairs.Appoint a dedicated person to be in charge of maintaining the repairs and maintenance schedule. Larger businesses may sometimes split this task among several people. For instance, the office manager might be charged with general office equipment and maintaining furniture, the IT manager charged with updating computers and software, while the plant manager is given the task of handling machinery.The final part of the repairs and maintenance schedule is developing a timeline for cleaning, lubricating, inspecting and servicing. Obviously, some items will require constant monitoring, while others might be checked weekly, monthly or annually. Having a stash of common replacement parts can help prevent operating delays. Of course, cost estimates can help borrowers budget for any anticipated repairs and maintenance.

Do your due diligence

Lenders need to monitor repairs and maintenance, as well. To start off, go to the client’s income statement and then compute repairs and maintenance expense as a percentage of revenues, gross fixed assets and net fixed assets. Such ratios should be stable over time and be comparable to other companies that are in the same industry. Ask your borrowers for industry benchmarking guidelines — many trade associations will include repairs and maintenance metrics in their studies.If a company has lower repairs and maintenance spending than its peers, it might signal that management is deferring upkeep to save money over the short run, which can jeopardize fixed assets over the long run. On the other hand, it might signal that management is keenly on top of its repairs and maintenance schedule, so major breakdowns are prevented, thus reducing long-term costs. Additional due diligence, including management inquiries and site visits, will uncover the true story.When you start benchmarking repairs and maintenance, keep in mind that some items will be capitalized on the balance sheet, instead of being expensed immediately. Under IRC Section 263(a), borrowers must record capitalized improvements if repairs lengthen an asset’s useful life or adapt it to a different use.

When it’s time to replace an asset

Often it’s smarter to replace a worn or broken asset than to repair or maintain it. For instance, buying a new furnace that will lower utility bills, improve reliability and require less upkeep may save a lot of money.Moreover, new equipment might qualify for Section 179 and bonus depreciation tax deductions. For 2013, the $500,000 Sec. 179 expensing limit begins to phase out dollar-for-dollar when total asset acquisitions for the tax year exceed $2 million. But, these amounts will drop to $25,000 and $200,000 respectively in 2014, unless Congress enacts further legislation.Keep in mind that replacing large items, such as a roof or servers, may require borrowers to create a replacement reserve and apply for additional financing. Before financing a replacement, however, inquire whether management has compared the costs and benefits of purchasing a new asset to the costs and benefits of repairing and maintaining a trusted old workhorse.

The final word

Borrowers should pay close attention to repairs and maintenance. Unfortunately, because of our uncertain economy, some may choose to treat upkeep as a discretionary expense. As a lender, you need to monitor this spending, so you can get a clearer picture of the quality of your borrowers’ loan collateral. Bottom line: When a client’s repairs and maintenance spending seems to be out of whack, contact your CPA.……………………………………………………………………………………….....................................................Freed Maxick’s Asset Based Lending Team works with dozens of asset based lenders across the country. We can assist you in evaluating the integrity of your customers’ collateral by performing pre-loan surveys and rotational collateral monitoring field examinations.We also have extensive experience in tax planning and consulting relative to fixed asset tax issues.For more information about our services for asset based lenders, contact me here, or call us at 716.847.2651.

 

Stay up to date