Asset Financing

What is Asset Financing?

Asset financing is a method where companies secure short-term institutional financing using assets listed on their balance sheet. The borrowing party must provide the lender with the assets as a security interest to the lending party.

There is a stark difference between traditional financing, like bank loans, and asset financing.

If the company secured its capital assets via traditional financing, it would have to pay regular interest payments on top of the principal borrowed from the lenders, who are generally financial institutions.

In traditional financing, companies have to demonstrate their cash flow for creditworthiness so that they can fill in their net working capital gaps.

On the other hand, asset financing is much preferable to traditional financing because asset financing is loaning off of the assets themselves, not the creditworthiness of the entire company.

The Two Ways of Asset Financing?

Asset financing is predominantly utilized for short-term financing, operations related, and poses more flexibility compared to regular bank loans.

Asset financing is very broad, but there are two primary procedures for a majority of asset financing. Either of these two procedures is employed for the many different types of financing assets, which are detailed further below.

1. Borrowing capital assets and paying it off 

The physically borrowed assets are assets not yet purchased by the business, but the business wants to borrow immediately without the expensive acquisition at full price. 

The capital expenditure for the full price could pose a strain on cash flow, inhibiting company growth, so borrowers tend to like this form of flexibility and shift short-term cash to other areas.

The assets that businesses borrow and that the financial institution lends to are tangible and fixed, i.e., property, plant, and equipment (PP&E) and real estate.

Both the creditor and debtor benefit from this arrangement because the debtor can make use of the capital assets for business operations, and the creditor is assured since they are the owners of those capital assets.

The creditors own the assets entirely until the borrower completes their regular interest payments and the principal itself. Only when the bank recoups the asset’s value, i.e., the loan is paid, will asset ownership change hands to the borrowing company.

2. Borrowing cash loans and pledging balance sheet assets as collateral

The company wants to borrow cash, not tangible assets, for working capital shortfalls. Like a home mortgage, the borrower uses the cash loan to acquire assets and guarantees those newly purchased assets as collateral to the lending finance company.

In a majority of cases, companies like to leverage short-term balance sheet assets, not fixed assets. Companies like to leverage their accounts receivables for short-term cash loans or working capital needs, but sometimes even their inventory as well, which isn’t uncommon.

Asset-based Financing vs. Asset Based Lending

At the basic level, both asset-based financing and asset based lending are the same thing, but with a small difference.

Types of Asset Finance

There are numerous different types of asset financing, even with their variants as well. They all adhere to the two procedures listed above for asset financing.

Hire Purchase

Commonly referred to as “lease purchase,” hire purchase involves the loan provider purchasing the asset on behalf of the borrower.  

The obligor makes interest rate charge payments to the creditor. The creditor retains ownership of the asset until the loan is paid, and after the final payment is delivered, the borrower has the option to transfer ownership at a nominal rate fee.

Equipment Lease

The company that borrows enters a contract with a lender to utilize equipment for its business up to a period to which both parties agree. The business delivers payments until the period of the contract ends. Once the lease is over, the company can return the rented equipment, extend the lease, upgrade the equipment, or buy it outright.

Operating Lease

Similar to an equipment lease but long-term in nature. Operating leases are longer tenured than equipment leases, but it’s not over the entire lifetime of the asset. Payments are reflected off the period borrowed, not the asset’s full value. An operating lease would be the most advantageous to businesses that need short to medium-term use of equipment.

Finance Lease

Also referred to as a “capital lease,” a finance lease 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.

The company doesn’t have the option to buy the asset altogether. Both sides of the table benefit from tax efficiencies because the creditor can claim capital allowances, and the borrower can refund any value-added taxes (VAT).

All rights and obligations of ownership are the responsibility of the borrower for the duration of the lease. Borrowers are responsible for the maintenance of the asset during the lease’s life.

Asset Refinance

Asset refinancing allows a business to secure a loan by pledging assets they currently own as collateral.

Any assets can qualify for borrowing technically as long as the lending party agrees. Instead of evaluating the firm based on creditworthiness, the bank only evaluates the pledged assets and produces a loanable amount off on the asset value.

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 the amount of equity in that item. Moreover, there is a variation called “Contract Hire or Vehicle Asset Challenge.”

Example

This example will be related to the auto industry because asset refinancing doesn’t occur in any other industry except the auto industry.

• 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.

Free Resources

To continue learning and advancing your career, check out these additional helpful WSO resources:

• Asset Protection
• Asset-Backed Commercial Paper (ABCP)
• Bank Credit Analysis Training
• Blended Rate
• Broker