What Is a Floating Charge?
A floating charge, also known as a floating lien, is a security interest or lien over a group of non-constant assets that may change in quantity and value.
Companies will use floating charges as a means of securing a loan. Typically, a loan might be secured by fixed assets such as property or equipment. However, with a floating charge, the underlying assets are usually current assets or short-term assets that can change in value.
- A floating charge is a security interest or lien over a group of non-constant assets that change in quantity and value.
- A floating charge is used as a means to secure a loan for a company.
- The assets used in a floating charge are usually short-term current assets that the company consumes within one year.
Understanding a Floating Charge
Floating charges allow business owners to access capital secured with dynamic or circulating assets. The assets backing the floating charge are short-term current assets, usually consumed by a company within one year. The floating charge is secured by the current assets while allowing the company to use those assets to run its business operations.
Current assets are those business possessions that the firm can quickly liquidate for cash and include the accounts receivable, inventory, and marketable securities, among other items. For example, if inventory is used as collateral for a loan, the company can still sell, restock, and change the value and quantity of its inventory. In other words, the value of the inventory changes over time or floats in value and quantity.
A floating charge is helpful to companies because it allows them to finance their operations by using current assets such as inventory.
Crystallization of Floating to Fixed Charges
Crystallization is the process by which a floating charge converts into a fixed charge. If a company fails to repay the loan or enters liquidation, the floating charge becomes crystallized or frozen into a fixed charge. With a fixed charge, the assets become fixed by the lender so the company cannot use the assets or sell them.
Crystallization can also happen if a company ends operations or if the borrower and lender go to court and the court appoints a receiver. Once crystallized, the now-fixed rate security cannot be sold, and the lender may take possession of it.
Typically, fixed charges are secured by tangible assets, such as buildings or equipment. For example, if a company takes out a mortgage on a building, the mortgage is a fixed charge, and the business cannot sell, transfer or dispose of the underlying asset—the building—until it repays the loan or meets other conditions outlined in the mortgage contract.
Floating Charge Example
Macy's Inc. is one of the largest department stores in the U.S. Let's say the company has entered into a loan with a bank using its inventory as collateral. The lender has ownership of the inventory, or a floating charge, as stipulated within the terms of the loan.
Below is a copy of Macy's balance sheet for the quarter ending November 3, 2018.
- November 3, 2018, the company's inventories, highlighted in green, had a value of $7.147 billion.
- However, in the previous quarter ending February 3, the value was $5.178 billion.
- We can see that inventory values fluctuate with each period because the total quantities and values change.
- The assets being secured for the loan are allowed to float or vary in price and quantity.