Updated July 13, 2023
What is Asset Financing?
Asset financing 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 to borrow money in a quicker timeframe.
Example of Asset Financing
A classic example is a business wishing to grow/expand its market. Mano Inc., a company engaged in cloth manufacturing, is looking to increase its production based on the high demand for its product.
In such a scenario, Mano Inc. may finance assets by regularly taking new production machinery on fixed payment plans. It is based on the terms agreed upon between the lender and Mano Inc.
This helps Mano. Inc continues its expansion plans without worrying about the initial investment to purchase new production machinery to fulfill the increased demand.
Types of Asset Financing
Asset financing can categorize 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, including all machinery, equipment, accounts receivables, and other assets.
Asset refinancing enables obtaining a loan in a shorter period, as it utilizes the value of the assets being pledged to determine the loan’s value. In this scenario, the business’s profitability and creditworthiness are 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 borrower’s requirements) and then lends it to the borrower for business use.
Here, the borrower makes regular payments to the lender over a mutually decided period. The borrower can purchase the asset at an agreed price (usually very nominal) after making the final payment.
This arrangement is useful to the borrower as he can pay in parts/installments.
3. Lease
A lease can be of 3 types: operating, finance, and equipment.
An operating lease is when an asset is borrowed from the lender for a 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 fulfill 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 using an asset to maintaining the asset is the sole responsibility of the borrower.
In the Equipment lease, agreement entrees between the borrower and the lender, allowing the borrower to use the equipment under agreed payment terms for an agreed period of time. At the end of tenure, the borrower can 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 no set numbers are prescribed regarding the amount that can raise with asset financing, countries may keep some specific conditions and restrictions in place.
You may understand that the loan amount can differ from party to party as, ultimately, the asset financing involves transactions between two parties for terms agreed upon mutually.
The loan amount will depend on the pledged asset, the loan granted, and any other terms the parties agree upon.
Why do we use Asset Financing?
Asset financing can secure an asset or a loan against an asset.
When a company goes for asset refinancing to secure an asset, it saves it from shelling out huge amounts to purchase such an 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, when 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 the business’s working capital needs. Considering it is easier to get loans by keeping the assets as collateral and the quick turnaround time to get the loan, 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.
- 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 a period of time help business owners in managing their finances
- Offers security – the amount of the 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
- The profitability of the business is not a concern, and hence even loss-making businesses can easily get loans through 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)
- You 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.
Conclusion
To summarize the whole discussion in a few words, asset financing helps a company fetch 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.
Recommended Articles
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 –
