What exactly is asset-based lending?
Asset-based lending is lending money in exchange for assets as security. Inventory, accounts receivable, equipment, and other items that belong to the borrower may be used as collateral for an asset-based loan or line of credit.
Asset-based lending is beneficial to the corporate community rather than to consumers. Additionally, it is called asset-based finance.
The Operation of Asset-Based Lending
Many firms must secure loans or lines of credit to satisfy their regular cash flow needs. For instance, a company could take up a line of credit to ensure that it can pay its payroll costs even if there is a small delay in the money it anticipates receiving.
The lender may offer to grant the loan with the borrower’s physical assets as collateral if the applicant firm cannot demonstrate sufficient cash flow or cash assets to cover the loan. For instance, a brand-new restaurant might be able to get a loan solely by pledging its equipment.
The kind and value of the assets supplied as security determine the terms and conditions of an asset-based loan. If the borrower falls behind on payments, lenders want highly liquid collateral, such as easily convertible stocks into cash. Since loans secured by physical assets are more risky, the maximum loan will be significantly less than the book value of the assets. Different interest rates are applied depending on the applicant’s credit history, cash flow, and the company’s terms.
Example
Consider a scenario where a business requests a $200,000 loan to grow its operations. The lender may approve a loan for 85% of the face value of the highly liquid marketable securities the firm pledges as security on its balance sheet. The lender will be ready to finance $170,000 if the firm’s securities are valued at $200,000. If the business puts less liquid assets, such as real estate or equipment, up front, it could only get offered $50,000 of the loan it needs, or $100,000.
The discount in both situations is meant to cover the costs of turning the collateral into cash and any potential loss in market value.
Particular Considerations
The most prevalent asset-based borrowers are small and mid-sized businesses that are reliable and have tangible assets with value.
Even major firms, meanwhile, occasionally look for asset-based loans to meet their immediate financial demands. Issuing more shares or bonds on the financial markets can be too expensive and time-consuming. The need for funds can be urgent, as in the event of a significant acquisition or an unanticipated equipment purchase.
Conclusion
- Asset-based lending is providing credit while utilizing the borrower’s assets as security.
- It is preferable to use liquid collateral rather than illiquid or tangible assets like equipment.
- Small and medium-sized firms frequently employ asset-based financing to meet short-term cash flow needs.
