What is Asset Financing
Asset financing refers to the use of a company’s balance sheet assets, including short-term investments, inventory and accounts receivable, to borrow money or get a loan. The company borrowing the funds must provide the lender with a security interest in the assets. This differs considerably from traditional financing, as the borrowing company must simply offer some of its assets to quickly get a cash loan.
BREAKING DOWN Asset Financing
Asset financing is most often used when a borrower needs 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 is becoming a more popular and common occurrence.
Asset Financing vs. Asset-Based Lending
At a basic level, asset financing and asset-based lending are terms that essentially refer to the same thing, with a slight difference.
With asset-based lending, in an instance where an individual borrows money to buy, for example, a home or even a car, the house or the vehicle serves as collateral for the loan. If the loan is not then repaid in the specified time period, it falls into default, and the lender may then seize the car or the house in order to pay off the amount of the loan. With asset financing, if other assets are used to help the individual qualify for the loan, they are generally not considered direct collateral on the amount of the loan.
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.
Secured vs. Unsecured Loans
Asset financing, in the past, was generally considered a last-resort type of financing; however, the popularity of this source of funding has grown. 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, wherein a company borrows, pledging an asset (equipment, stocks, warehouses or accounts receivable) 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 wagered 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; thus, secured loans usually have a lower interest rate.