Asset financing refers to the use of a company’s balance sheet assets to borrow money or get a loan. That is inclusive of short-term investments, inventory and accounts receivable.
The company borrowing the funds must provide the lender with a security interest in the assets.
Understanding Asset Financing
Asset financing differs significantly from traditional financing, as the borrowing company offers some of its assets to quickly get a cash loan.
A traditional financing arrangement, such as a project-based loan would involve a longer process including business planning, projections, and so on.
Borrowers most often use asset financing when they need a short-term cash loan or working capital. In most cases, the borrowing company using asset financing pledges its accounts receivable. However, the use of inventory assets in the borrowing process otherwise known as warehouse financing is not uncommon.
Asset Financing and Asset-Based Lending: Difference
Basically, asset financing and asset-based lending are terms that essentially refer to the same thing. However, they have a slight difference. With asset-based lending, when an individual borrows money to acquire property, the property serves as collateral for the loan. If the loan is not then repaid in the specified time period, it falls into default. The lender may then seize the property to pay off the loan amount. The same concept applies to businesses buying assets.
With asset financing, lenders generally do not consider other assets used to help an individual qualify for the loan as direct collateral on the loan amount. The lender may include an agreement that bans the borrower from using pledged assets to secure other loans.
Asset financing is typically used by businesses, which tend to borrow against assets they currently own. Accounts receivable, inventory, machinery, and even buildings and warehouses may be offered as collateral on a loan.
These loans are almost always used for short-term funding needs, such as cash to pay employee wages or to purchase the raw materials that are needed to produce the goods that are sold. So, the company is not purchasing a new asset but using its owned assets to make up a working cash flow shortfall. If, however, the company goes on to default, the lender can still seize assets and attempt to sell them to recoup the loan amount.
Secured and Unsecured Loans in Asset Financing
Asset financing, in the past, was generally considered a last-resort type of financing. Nonetheless, the stigma around this source of funding has lessened over time. This is primarily true for small companies, startups and other companies that lack the track record or credit rating to qualify for alternative funding sources.
There are two basic types of loans that may be given. The most traditional type is a secured loan. Here, a company borrows, pledging an asset against the debt. The lender considers the value of the asset pledged instead of looking at the creditworthiness of the company overall. If the loan is not repaid, the lender may seize the asset that was pledged against the debt.
Unsecured loans do not involve collateral specifically. However, the lender may have a general claim on the company’s assets if repayment is not made. If the company goes bankrupt, secured creditors typically receive a greater proportion of their claims. As a result, secured loans usually have a lower interest rate, making them more attractive to companies in need of asset financing.
