What is Asset Financing?
Asset financing basically refers to borrowing money or getting a loan against your company’s business assets, whether long term or short-term investments, fixed and current assets, including inventory. In other words, it refers to the pledging of assets in order to borrow money in a quicker timeframe.
Example of Asset Financing
A classic example can be that of a business wishing to grow/expand its market. Lets’ say Mano Inc., a company engaged in cloth manufacturing, is looking to increase its production based on high demand for its product.
In such a scenario, Mano Inc. may go ahead with asset financing by taking new production machinery on fixed payment plans at regular intervals. Definitely based on the terms agreed upon between the lender and Mano Inc.
This helps Mano. Inc is going ahead with its expansion plans without worrying about the initial investment to purchase new production machinery to fulfil the increased demand.
Types of Asset Financing
Asset financing can be categorised in majorly three types:
1. Asset Refinance
Asset Refinancing is when you pledge the company’s assets as collateral for securing a loan. For example, the company may take a loan with balance sheet assets and include all machinery, equipment, accounts receivables, and any other asset.
Asset refinancing helps in getting a loan in a shorter span of time as the value of a loan is determined based on the value of the assets being pledged. In this scenario, the profitability of the business and credit worthiness of the company is not required to be verified and thus is a quicker process to get a loan.
2. Hire purchase
In the case of a hire purchase agreement, there are two parties, one the lender and the other the borrower. In such an arrangement, the lender buys an asset from the market or third party (according to the requirements of the borrower) and then lends it to the borrower for his business use.
Here, the borrower makes regular payments to the lender over a mutually decided period of time, and once the final payment is made, the borrower may decide to buy the asset at an agreed price (which is usually very nominal).
This arrangement is useful to the borrower as he can pay in parts/instalments.
A lease can be of 3 types, namely, operating lease, finance lease and equipment lease.
An operating lease is when an asset is borrowed from the lender for short to medium timeframe. It is helpful for the business as the payments made are only towards using the asset for the required time period and helps fulfil business needs.
The finance lease has its main object of giving the borrower the rights and obligations of the asset under lease for the duration of the lease. From the use of an asset to maintaining the asset is the sole responsibility of the borrower.
In the Equipment lease, an agreement is entered into between the borrower and the lender, which allows the borrower to use the equipment under agreed payment terms for an agreed period of time. At the end of tenure, the borrower can decide to either return or buy the equipment, extend the lease or go for better equipment.
What are the minimum and maximum amounts that can raise with Asset finance?
Although there are no set numbers prescribed regarding what is the amount that can be raised with asset financing, countries may keep some specific conditions and restrictions in place for the same.
You may understand that the loan amount can differ from party to party as ultimately the asset financing involves transactions taking place between two parties for terms agreed upon mutually.
The loan amount will be based upon the asset being pledged, the loan is granted, and any other terms that the parties agree upon.
Why do we use Asset Financing?
Asset financing can be used to either secure an asset or secure a loan against an asset.
When a company goes for asset refinancing for the purpose of securing an asset, it saves the company from shelling out huge amounts for the purchase of such asset. The company can easily manage its working capital requirements and make regular payments to secure the asset necessary to run the business.
On the other hand, where the company plans to go for asset financing by way of pledging the asset, it achieves the purpose and requirements of short-term loans and working capital needs of the business. Considering it is easier to get loans by keeping the assets as collateral and the turnaround time to get the loan is quick, it attracts many companies to go for asset financing.
Advantages of Asset Financing
- It saves the hassle of accumulating huge funds for outright buying the assets for a business.
- Definitely an affordable option for new and growing businesses
- Offers flexibility as the lender and borrower may mutually decide upon the repayment structure
- Fixed payments over the period of time help the business owners in managing their finances
- Offers security – the amount of loan is roughly equal to the value of the asset, thus keeping both parties safe
- Any adverse credit rating of the borrower may not be an issue
- Profitability of the business is not a concern, and hence even loss-making businesses can easily get loans by this method
Disadvantages of Asset Financing
- It May prove to be expensive if the interest charges and service charges are on the higher side (based on negotiations between the parties)
- May need to make a down payment/deposit upfront, which may entail having a certain amount of funds upright (based on negotiations between the parties)
- In case of payment default, the lender may seize the asset given as collateral.
- Repairs and Maintenance of the assets can be an additional expense burden
- In the lease model, usually, the lender is the owner of the asset, and in case the asset being recalled or taken from a borrower, it can impact the business of the borrower
Key Takeaways for Asset Financing
Asset financing gives the companies the flexibility to plan for investing in the assets. Also, it helps companies borrow money quicker by pledging their assets, including inventory and accounts receivables.
Considering that the lender can seize the asset in case of default, it gives the lender the security of the loan given.
To summarize the whole discussion in few words, asset financing helps a company fetching a loan by pledging its assets and thus managing any working capital requirements for the short term.
It is also good for new and growing companies or companies that often have short-term working capital requirements. The loan is taken based on its valuable assets and not on its profitability and creditability.
This is a guide to Asset Financing. Here we also discuss the definitions, types, and examples of Asset Financing along with the advantages and disadvantages. You may also have a look at the following articles to learn more –