The Pros and Cons of Asset Based Financing
Asset-based financing is a way to borrow money by putting your company’s existing assets up as collateral. Companies use asset-based finance to get lower rates, larger quantities, and more extended periods by using their assets as collateral for a loan, limiting the lender’s loss if they default on payments owing to rapid expansion or an unexpected but costly opportunity. Understanding the purposes, requirements, and best cash flows for asset financing and asset loans is essential. Because business owners are putting up a piece of their company as security for the funding to go successfully, you want to be sure you don’t lose that asset.
It’s also crucial for company owners to grasp the difference between asset-based finance and other forms of financing. An inventory or equipment line of credit is secured by inventory or equipment assets, whereas factoring involves the purchase of future receivables rather than current assets. In asset-based finance, assets are usually liquid currency, but they may also be products.
What are assets?
Let’s start with assets. Cash is the most frequent kind of working capital utilized by businesses. However, working capital does not apply to all assets. Working capital is defined as the capacity to use an asset as a payment currency for your daily expenses. While property and equipment are valuable assets, they do not necessarily translate into operating capital. Cash, inventory, prepaid costs, debtors, and current liabilities are examples of working capital assets.
Liquid assets are beneficial when seeking asset-based financing since they protect your company from sinking. A liquid asset can be quickly converted into cash, such as cash in marketable securities. More liquidity means a more dynamic and responsive company, which is crucial for success. You want liquid assets, but you also don’t want unused liquid money, and it’s a missed chance for growth and investment.
Why would you use asset-based financing?
This type of financing is used to bridge cash flow and payroll gaps and can be used to refinance existing loans, expand through mergers, acquisitions, buy-outs, and invest in equipment and inventories.
Asset-based financing is necessary because of rapid expansion and cash flow problems. It would be simpler for a new but expanding firm to obtain approval for anything backed by an asset or other collateral if they appear to be a risk on paper due to a short time in business or an uneven balance sheet.
Asset-based lenders prefer physical assets like equipment and inventory over highly liquid collateral like marketable securities. If the company requesting the loan does not have sufficient cash flow or cash assets to cover the loan, the lender may offer to fund the loan using the company’s physical assets. For example, a new medical practice can acquire an asset loan simply by putting its equipment as collateral. Small and medium-sized businesses need short-term cash flow requirements regularly typically employ asset-based lenders. This can assist a larger corporation in realizing economies of scale and lowering total expenses.
For various reasons, a firm may select asset lending over a traditional loan, such as a bank loan.
A firm that has exceeded its vendor credit constraints, as well as its bank debt limits, may find this financing option intriguing. However, the firm will be operating at capacity if it cannot finance raw supplies in sufficient quantities to fulfill all requests. Asset funding is used to buy order finance, in which the lender obtains the required raw materials. Once the orders are filled, the vendor pays the lender, and the lender deducts its expenses and fees before remitting the remaining funds to the firm.
This purchase order financing, while necessary for keeping operations going, comes with hefty interest rates.
Time-sensitive possibilities are standard with this type of financing. A firm facing an immediate opportunity or setback cannot afford to wait for a bank loan to complete paperwork and be underwritten. They can borrow money by pledging current assets if they require cash immediately.
You might be wondering why you’d want to use a cash asset to make more money. If lenders require a liquid asset, why not utilize it yourself? You are making money if you invest in a marketable security. You’d prefer to retain the funds in that account, but you can use it to raise more money to help you manage and grow your company. You may also be anticipating late bills and need to make up the difference with cash.
Examples of assets
As you may be aware, asset-based finance can take the shape of cash or equipment, but it goes much farther. ; it’s a combination of working capital in numerous forms and from many sources. The following are examples of assets:
- Accounts payable is a term that refers to the amount of money owed to you
- Instruments and apparatus
- Property or real estate
- Securities that can be sold
- Accounts for investments, checks, and savings
- Invoices and Purchase Orders
- Another source of revenue that may be sent straight to the lender
What’s the difference between factoring and an asset-based loan?
Asset-based loans are commonly mistaken with factoring since they involve invoices and potential receivables. Despite their differences, both products offer similar advantages. A factoring transaction does not include a loan or borrowing of funds. The financially-strapped company sells its future receivables to improve its current cash flow. This is similar to an invoice-backed line of credit, where money is given in exchange for the promise of future revenue.
Asset loans and factoring are two options for small firms with weak credit or restricted cash flow. Factoring seldom uses collateral, which can be advantageous for businesses with few assets, cash, or equipment.
What’s the difference between an asset loan and a credit line?
Equipment lines of credit and inventory lines of credit are commonly used interchangeably with asset lending since they are both a type of asset financing that uses an item as security. On the other hand, asset lending is not always a line of credit, and a set-payment loan can also be secured using a company’s assets.
What if I don’t have any liquid assets?
Yes, lenders prefer liquid collateral like market securities and invoices converted to cash if the borrower defaults. Physical asset loans are riskier since the collateral item may take longer to collect and sell, resulting in a total loan or financing amount substantially lower than the assets’ book value. Borrowers with cash assets may expect to have 70-85% of their assets used for funding. The firm may only acquire half of the capital it requires if it has less liquid assets like real estate or equipment.
This is an excellent time to start if you don’t already have any monetary assets. Market securities are a common investment alternative for companies since they take idle liquid capital and return it. Instead of putting your money in a savings account that earns little or no interest, you may invest a portion of it in short-term liquid assets.
If your firm is unable to obtain asset finance, another cash-flow-related program may be a better option.
Got some questions?
Asset based financing is providing lenders with personal assets as collateral to receive working capital for your business. Assets can range from real estate to machinery.
It’s a form of financing used to cover any gaps in a business where cash flow is needed. It’s a good source of short-term loan use.
When you apply for an asset based loan, you and the provider will work out terms and conditions that will set up how much the loan will be. From there, the provider will purchase the equipment needed for your business and take over the assets on a lease.
Over your term agreement, your business will make regular payments to what is owed. Once you’ve paid off in full, the provider will offer you your asset back under lease at the nominal value.
When it come to asset based financing, there are a few options:
- Asset Refinance
- Equipment Lease
- Financial Lease
- Operating Lease
Only you can determine if asset based financing is the best solution for your business.It’s good if you’re looking to use it for account receivables, inventory or property.
Be mindful that this involves putting your personal assets up as collateral for leasing. Make sure you’re comfortable with others having temporary access to your assets.
There are the few grand perks of asset based financing. They include financial stability, flexible restriction terms, and lack of debt.
Asset based loans do generally cost more than traditional bank loans which is a downside. It is ultimately your decisions on how you weigh the pros to the cons in order to make your final decision.
Having a healthy business means that it’s running well and you’re staying on top of all the business priorities. Lenders take notice in things like this when reviewing your application.
Credit score isn’t everything in this case. We won’t automatically deny you because it’s lower than average.
A helpful tip: if you have more than one asset for collateral, use the one you feel is most valuable in long-term profit for your financing.