Asset Financing

The borrowing or lending of money using a company's balance sheet assets

Author: Ely Karam
Ely  Karam
Ely Karam
Ely Karam, I hold a bachelor's degree in pure mathematics with a minor in business administration at AUB. Currently, I am finishing my master's degree in finance at AUB. As for my experience, I work as an investment analyst full-time and as a financial consultant part-time. I tutor mathematics, financial accounting, and corporate finance as well.
Reviewed By: Osman Ahmed
Osman Ahmed
Osman Ahmed
Investment Banking | Private Equity

Osman started his career as an investment banking analyst at Thomas Weisel Partners where he spent just over two years before moving into a growth equity investing role at Scale Venture Partners, focused on technology. He's currently a VP at KCK Group, the private equity arm of a middle eastern family office. Osman has a generalist industry focus on lower middle market growth equity and buyout transactions.

Osman holds a Bachelor of Science in Computer Science from the University of Southern California and a Master of Business Administration with concentrations in Finance, Entrepreneurship, and Economics from the University of Chicago Booth School of Business.

Last Updated:September 22, 2023

What Is Asset Financing?

Asset financing is the practice of borrowing money or receiving a loan using the assets listed on a company's balance sheet, such as short-term investments, inventory, and accounts receivable. A security interest in the assets must be given to the lender by the business borrowing the money.

It is the borrowing or lending of money using a company's balance sheet assets, such as short-term investments, inventories, and accounts receivable. A security interest in the assets must be given to the lender by the company borrowing the money.

The first includes businesses employing finance to secure the use of assets such as equipment, machinery, real estate, and other capital assets. A corporation will fully use the asset for a specified time and make regular payments to the lender for its usage.

The second type is employed when a business seeks to get a loan by putting its assets as security. A conventional loan provides cash based on a company's creditworthiness and the prospects of its business and initiatives.

The value of the assets themselves decides asset financing loans. However, it might be a viable option when a firm cannot obtain regular finance.  

Asset finance varies significantly from typical financing in that the borrowing firm gives part of its assets in exchange for a rapid cash loan. 

A typical financing arrangement, such as a project-based loan, would include a more time-consuming procedure consisting of business planning, forecasts, etc. Asset finance is frequently employed when a borrower needs a short-term cash loan or operating capital. 

The borrowing business often promises its accounts receivable when employing asset finance. Nevertheless, using inventory assets in the borrowing process is not unusual.

Why do we use Asset Financing?

It is frequently utilized as a short-term financing option to pay staff and suppliers or to support expansion. As opposed to typical bank loans, it offers a more flexible method of financing. In addition, it provides a straightforward approach to raising working capital for expanding enterprises and start-ups.

The two primary uses are:

1. Securing the use of assets

Capital expenditures for outright asset acquisitions may impact a company's working capital and cash flow. It enables a business to purchase the assets it needs to operate and grow while maintaining the financial flexibility to shift money to other areas.

Complete asset acquisition can be expensive, risky, and restrict a company's ability to grow. Therefore, this financing is an effective way for a business to get the assets it needs without paying astronomical prices.

Both lenders gain from the asset financing arrangement (banks and financial institutions) and the borrowers (companies). Therefore, it is usually safer for lenders than traditional lending.

A conventional loan necessitates the lending of a big quantity of money, which the bank intends to recoup. When a bank lends an asset, they know they can recoup at least the asset's value. Furthermore, if borrowers fail to make payments, the lender may confiscate their assets.

2. Securing a loan through assets

This financing also refers to a situation in which a business seeks to get a loan by putting up assets from its balance sheet as security. Since funding is based on the value of the assets rather than the company's creditworthiness, businesses will choose asset finance over conventional financing.

Assets will be removed from the company if it doesn't repay its loans. PP&E, inventories, accounts receivable, and short-term investments are assets that can be pledged against such loans.

Early-stage and smaller businesses sometimes have difficulties with lenders because they lack the credit rating or track record required to receive a standard loan.

However, through asset financing, they can get a loan based on the assets they need to acquire finance for their day-to-day operations and growth.

It is frequently used to improve working capital and liquidity to meet short-term financial demands. Payroll for employees, supplier payments, and other urgent needs are only a few of the uses for the money.

All firms find loans enticing since they are frequently quicker and easier. They have fewer covenants and restrictions, so they are easier to utilize. The loans often come with a predetermined interest rate, which helps the company manage its cash flow and budget.

Types of asset financing

There are numerous significant categories of asset financing, as well as a few minor variants. Each has its advantages and limitations, but they all adhere to the above-mentioned rules.

It has five primary types:

1. Hire Purchase

It is also known as a "lease purchase," where the lender acquires the asset on behalf of the borrower. The borrower will pay the lender over time to pay off the support. The lender now owns the asset until the debt is paid off. Then, the borrower will be allowed to acquire the asset for a minimal fee after the last payment.

2. Equipment Lease

Because of their independence and flexibility, equipment leases are attractive asset financing choices. The business (borrower) will enter into a contractual arrangement with a lender to utilize the equipment for its business for an agreed-upon time for such a lease.

The firm makes payments until the contractual time expires. When the lease expires, the company can either return the borrowed equipment, renew the lease, upgrade to newer equipment, or purchase the equipment entirely.

3. Operating Lease

An operational lease is similar to an equipment lease, except that equipment leases are often for short periods. In contrast, operating leases are generally for more extended periods, although not for the whole life of an asset.

As a result, operational leases are frequently less expensive because the asset is borrowed for a shorter period.

Payments are only recorded for the period the asset is utilized, not for the total value of the item. As a result, operating leases are advantageous to firms seeking short- to medium-term use of equipment to meet their demands.

4. Finance Lease

It can be called "capital lease"; as it differs from other types of asset financing in that the company only ever rents the assets involved. But, again, money is provided in monthly installments according to an agreed-upon plan. 

This usually lasts until the financing provider has recouped the asset's purchase price. In some cases, the financing company may allow the firm to receive a portion of the sale price of an item after it has been sold. The company does not have the option of buying the asset altogether.

A company may be able to deduct rental payments from its profits for tax purposes. Long financial leases, on the other hand, make this impossible. 

The loan firm retains the right to capital allowances, but the business is allowed to recover VAT. The borrower assumes full ownership rights and duties for the lease term, which is a distinguishing feature of the financing lease. During the lease term, the borrower is responsible for the asset's upkeep.

5. Asset Refinance

Asset refinancing is used when a company wishes to obtain a loan by offering current assets as security

Assets like real estate, automobiles, equipment, and accounts receivable are used to qualify for loans. Instead of appraising the firm based on its creditworthiness, the bank will evaluate the pledged assets and produce a loan amount based on the asset value. 

There are two types of asset refinancing: 

  • The first is simply utilizing a company's assets (physical or intangible) as collateral for a loan.
  • The second, more appropriately known as asset-based lending, occurs when a company sells an asset to an asset financing provider for an agreed-upon lump payment. The company then leases back the asset from the loan provider, recouping the lump sum paid.

Asset refinancing varies from a standard secured loan in that a company can utilize physical assets that it only partially owns as security, but only up to the amount of equity in that item.

Moreover, there is a variation called "Contract Hire or Vehicle Asset Challenge."

This type of asset finance solely applies to autos. A company that wants to grow its fleet will contact a contract hire supplier, who will locate the necessary vehicle(s). The company makes regular payments over the agreed-upon lease term.     

Maintenance and service expenditures are the provider's responsibility, not the business's. Fleet management services may be included in the standard contract hire fees for more prominent organizations with several cars.

Contract hire has the advantage of freeing a corporation of the time and money-consuming tasks that come with standard vehicle ownership. 

The supplier is responsible for locating and purchasing a new car and all maintenance and servicing expenses. The supplier also bears responsibility for the vehicle's disposal after the lease period.

Advantages and disadvantages of asset financing

Despite its practical benefits, asset financing isn't without drawbacks.

While it provides immediate access to capital, enhances cash flow, and may offer tax benefits, it also exposes businesses to risks such as asset depreciation, higher interest costs, and potential loss of assets.

The advantages of Asset Financing include:

  • Traditional bank loans are more challenging to get.
  • Fixed payments simplify planning and cash flow management.
  • The majority of contracts have fixed interest rates.
  • Failure to pay results solely in the loss of assets, nothing else.
  • When employing asset finance to acquire a high-value item, the equipment serves as collateral for the loan.
  • If you lease or hire expensive equipment or cars, the supplier is responsible for all maintenance and service charges, not your company (depending on the type of finance deal arranged).
  • It avoids using critical capital for purchases, allowing enterprises to put this money to use better.
  • The risk of depreciation may lie on the provider rather than the company. Furthermore, if the item has to be replaced before the end of the agreed-upon asset finance period, the supplier must return it at their own expense (depending on the type of finance deal arranged).

The disadvantages of Asset Financing are:

  • There is a threat of losing critical assets essential for corporate operations.
  • The value of the assets used to secure a loan might vary, with low values possible.
  • Not as successful for long-term funding.
  • Failure to pay will result in the removal of the equipment. This might cause significant issues if it is a critical component of your firm.
  • Unless otherwise indicated, leasing or hiring contract financing may imply paying for an object you will never own.
  • A standard loan arrangement may not cover damage not covered by service or maintenance (such as accidental damage). This implies you'll have to pay for it or seek appropriate insurance.

Many firms can benefit from asset finance, but ensuring that this financing strategy is appropriate for your business model is critical.

Asset Financing Vs. Asset-Based Lending

Asset-based financing uses real estate or vehicles as collateral for loans made to people who want to buy homes or cars.

If additional assets are utilized to assist the borrower in qualifying for the loan, they usually are not considered direct security on the loan amount with asset financing.

The loan defaults if it is not returned within the specified time frame, and the lender may seize and sell the car or other property to recoup their loss. At their most fundamental, asset finance and asset-based lending are phrases that essentially mean the same thing, with a minor distinction.

Businesses typically use it to borrow against assets that they already own. For example, a loan might be secured by receivables, stock, equipment, buildings, and warehouses. 

These loans are typically utilized for short-term financial needs, such as funds to pay staff wages or acquire raw materials needed to manufacture the offered items. 

As a result, the company is using its current assets to compensate for a shortfall in operating cash flow rather than purchasing a new asset. The lender may still take assets and sell them to recoup the loan balance if the company defaults.

Secured and Unsecured Loans in Asset Financing

Asset financing was formerly seen as a last-resort mode of financing, but over time, this source of cash has lost some of its stigmas. 

This is especially true for small enterprises, new companies, and other organizations that lack the credentials to be approved for traditional funding sources, such as a track record or credit rating.

Loans can be made in one of two ways. The most typical type of loan requires a firm to pledge an asset as collateral for the debt or a secured loan. 

The lender evaluates the value of the pledged asset rather than the firm's overall creditworthiness. The lender may seize the item pledged as security for the debt if the loan is not paid back.

Unsecured loans don't need security, but the lender can have a strong claim on the business's assets if they aren't paid back. 

If the company declares bankruptcy, secured creditors frequently receive a more significant portion of their claims. Due to this, fast loans often offer lower interest rates, making them more alluring to companies needing funding.

What Assets Can Be Financed?

There is no general rule for an asset to be financed; however, providers will consider a wide range of high-value products for Purchase, leasing, or borrowing. 

These assets preferably fit the DIMS standards. That is to say, the assets at issue are: 

  • Durable: they are capable of generating flows of goods and services 
  • Identifiable: consists of anything that can be separated from the business and disposed of, such as machinery, vehicles, buildings, or other equipment.
  • Moveable: any asset item that can be removed without causing material damage to the Project Area or any permanent structures thereon.
  • Saleable: an engine or any Equipment that :
  1. is an Eligible Asset.
  2. is held for sale, consignment, or in inventory and is not subject to a Lease.
  3. is not unmerchantable or obsolete, 
  4. is physically tagged or identifiable by part or serial numbers
  5. complies with all applicable Aviation Authority requirements.

Furthermore, two types of assets may be financed: hard assets and soft assets.

1. Hard Assets: These are physical assets, as the name indicates, and might comprise high-value goods such as machinery, plant, equipment, or cars. Buildings, warehouses, and other commercial properties can also be considered under such financing.

2. Soft Assets: These are less durable items that may have little to no resale value by the time the loan arrangement expires. This can include software packages, IT equipment, furnishings, electronics (including CCTV, security systems,...), and other equipment with a limited lifespan.

It is excellent for any company that wants to purchase assets to develop and function more effectively. It may be suited for many businesses, including single proprietorships, small to medium-sized firms, and more prominent corporations.

Lastly, asset financing can purchase equipment, machinery, and even automobiles. It can also free up capital in existing assets (a refinance). Asset finance can help spread the expense of high-value products, and regular payments may make budgeting easier.

Researched and authored by Ely Karam | LinkedIn

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