What is Asset Financing?- Types, and Importance

What is Asset Financing?

Asset financing is the practice of using a company’s balance sheet assets (such as investments or inventory) as a security to borrow money or take out a loan against what you already own. It can provide a secure and easy way of getting working capital for your business

Asset financing is a type of borrowing related to the assets of a company. In asset financing, the company uses its existing inventory, accounts receivable, or short-term investments to secure short-term financing.

There are two ways to finance assets:

The first involves companies using financing to secure the use of assets, including equipment, machinery, property, and other capital assets. A company will be entitled to full use of the asset over a set period of time and will make regular payments to the lender for the use of the asset.

The second variation of asset financing is used when a company looks to secure a loan by pledging the assets they own as collateral. With a traditional loan, funding is given out based on the creditworthiness of a company and the prospects of its business and projects.

Loans given out through asset financing are determined by the value of the assets themselves. It can be an effective alternative when a company is not qualified to secure traditional financing.

Asset Financing

Key Takeaways

  • Asset financing allows a company to get a loan by pledging balance sheet assets.
  • Asset financing is usually used to cover a short-term need for working capital.
  • Some companies prefer to use asset financing in place of traditional financing as the financing is based on the assets themselves rather than the bank’s perception of the company’s creditworthiness and future business prospects.
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Types of Asset Finance

Generally speaking, there are two types of asset finance lending secured against existing assets, and equipment finance to get additional assets. Depending on the type of asset finance, the borrower can eventually take on full ownership of the asset, return it to the lender or lease a newer version.

1. Hire Purchase

Hire purchase (HP) or leasing is a type of asset finance that allows firms or individuals to possess and control an asset during an agreed term while paying rent or installments covering depreciation of the asset, and interest to cover the capital cost. On completion, ownership of the asset transfers to the customer.

2. Equipment Lease

An equipment lease agreement is a contractual agreement where the lessor, who is the owner of the equipment, allows the lessee to use the equipment for a specified period in exchange for periodic payments. The subject of the lease may be vehicles, factory machines, or any other equipment.

It is a very popular option for asset financing because of the freedom and flexibility it comes with. Payments are made by the business until the contractual period ends. Once the lease is up, the business can either return the rented equipment, extend its lease, upgrade to the latest equipment, or buy the equipment outright.

3. Operating Lease

An operating lease is an agreement to use and operate an asset without the transfer of ownership.  It is similar to an equipment lease, except equipment leases are usually for short terms, and operating leases are typically longer but not for the full life of an asset.

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As a result, operating leases are often a cheaper option since the asset is being borrowed for a shorter amount of time. Payments are only reflected for the time the asset is used and not for the asset’s full value. Operating leases are beneficial to businesses looking for short to medium-term use of equipment to fulfill their needs.

Common assets. Examples include property, plant, and equipment. Tangible assets are that are leased include real estate, automobiles, aircraft, or heavy equipment.

4. Finance Lease

The defining feature of the finance lease is that all rights and obligations of ownership are taken on by the borrower for the duration of the lease. The borrower holds responsibility for the maintenance of the asset during the life of the lease.

5. Asset Refinance

Asset Refinance is a secured loan, repaid using Fixed Monthly Repayments over an agreed period, or term, that can extend as far as 5 years. Fixed Monthly Repayments involve your business paying an agreed sum at the end of each month until the agreement has been fully repaid, plus interest.

Assets, including property, vehicles, equipment, and even accounts receivables, are used to qualify for borrowing. Rather than a bank judging the business on its creditworthiness, the bank will value the pledged assets and create a loan size based on the value of the assets.

Why use Asset Finance?

Asset financing is often used as a short-term funding solution – to pay employees, suppliers or to finance growth. It provides a more flexible way of borrowing compared to traditional bank loans. For growing businesses and start-ups especially, it provides an easy way to increase working capital.

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How does asset finance work?

Asset finance is the practice of using a company’s balance sheet assets (such as investments or inventory) as a security to borrow money or take out a loan against what you already own. It can provide a secure and easy way of getting working capital for your business.

Various things can be offered as collateral, from inventory, machinery, and even buildings. For example, a transport company may use its vehicles as an asset to secure finance against. The amount loaned will usually depend on the value of these assets to which the finance is secured.

Advantages And Disadvantages

Advantages of asset finance:

  • Easier to obtain than traditional bank loans
  • Fixed payments make budgeting and cash flow simple to manage
  • Most agreements have fixed interest rates
  • Failure to pay only results in the loss of assets, nothing more

Disadvantages of asset-based finance:

  • There is the risk of losing important assets required for running a business
  • Value of the assets which a loan is secured against can vary, with the possibility of low valuations
  • Not as effective for securing long term funding

Asset finance can help many businesses, but it’s important to be sure this financing method is right for your business model.