Asset FinancingDefined with Examples & More
What is Asset Financing?
Firms who wish to apply for a loan or financing use their Balance Sheet assets as a form of security for the loan.
This is called Asset Financing.
The assets used as security in the loan include Accounts Receivable, Inventory, or Short-term Investments.
Understanding Asset Financing
The purpose of acquiring a loan in Asset financing differs from traditional financing.
For short-term financing needs such as additional working capital and payment for short-term debts, asset financing is typically the preferred option.
Traditional financing takes time to complete and generally requires projections and business planning – a process that will not work for immediate borrowing concerns.
Companies use not only the current assets of the company but also the classified quick assets like receivables and marketable securities because these are the assets that are easily convertible into cash.
Some firms prefer to pledge their Balance Sheet Assets as a form of security in an asset financing transaction because it is based on the assets and not the creditworthiness of the firm.
The Difference Between Asset Financing and Asset-Based Lending
Asset Financing and Asset-based lending are the same in a way that both require security to be approved for a loan.
The difference lies in how these assets are used as a form of security.
In Asset-Based Lending, the asset is used as collateral for the loan.
This means that when the borrower fails to make payments on the loan, the lender has the right to seize or sell the property so that the loan will be paid back.
In Asset Financing, the assets used are not directly considered as collateral of the loan, although it works just like asset-based lending in securing the approval of the loan.
The purpose of borrowing additional funds in Asset financing is to augment the shortage of cash to settle short-term business needs.
Most of the time, the collateral used is highly liquid assets because they can be easily converted to cash such as accounts receivable, money market instruments, marketable securities, and even inventories.
In case the borrower defaults on the payment, the lender will still have the option of taking the collateral to sell it to cover the unpaid loan balance.
Secured and Unsecured Loans in Asset Financing
Back in the day, asset financing was the least acquired source of financing.
However, the stigma around this type of financing has lessened over time and is now one of the most availed loan products by business enterprises, especially business start-ups and firms that are yet to establish a good credit rating.
There are two types of borrowing – Secured and Unsecured Loans.
The secured type of borrowing is a collateral-based loan.
The collateral is pledged by the borrower to use as a security for the loaned amount.
The loanable amount will be based on the market value/face value of the collateral.
The advantage of this type of loan is that the lender may provide a lower interest rate with more favorable terms.
Should the borrower default, the lender can take the collateral pledged as payment for the unpaid loan balance which they can sell and use the proceeds from the sale to settle the loan.
Unsecured Loans do not need collateral. The basis of loan approval is the creditworthiness of the borrower.
Should the borrower fail to pay the loan or goes bankrupt, the lender will still have a claim on the company’s assets.
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Minnesota Law Review "Current Assets Financing as a Source of Long-Term Capital" Publication. August 3, 2022
Harvard Law School "Financing Through Asset Sales" Page 1. August 3, 2022