Why loan is asset

 What Is Asset-Based Lending?

Asset-based lending is the business of loaning money in an agreement that is secured by collateral. An asset-based loan or line of credit may be secured by inventory, accounts receivable, equipment, or other property owned by the borrower.

The asset-based lending industry serves business, not consumers. It is also known as asset-based financing.

KEY TAKEAWAYS

Asset-based lending involves loaning money using the borrower's assets as collateral.

Liquid collateral is preferred as opposed to illiquid or physical assets such as equipment.

Asset-based lending is often used by small to mid-sized businesses in order to cover short-term cash flow demands.

How Asset-Based Lending Works

Many businesses need to take out loans or obtain lines of credit to meet routine cash flow demands. For example, a business might obtain a line of credit to make sure it can cover its payroll expenses even if there's a brief delay in payments it expects to receive.

If the company seeking the loan cannot show enough cash flow or cash assets to cover a loan, the lender may offer to approve the loan with its physical assets as collateral. For example, a new restaurant might be able to obtain a loan only by using its equipment as collateral.

The terms and conditions of an asset-based loan depend on the type and value of the assets offered as security. Lenders prefer highly liquid collateral such as securities that can readily be converted to cash if the borrower defaults on the payments. Loans using physical assets are considered riskier, so the maximum loan will be considerably less than the book value of the assets. Interest rates charged vary widely, depending on the applicant's credit history, cash flow, and length of time doing business.

 Interest rates on asset-based loans are lower than rates on unsecured loans since the lender can recoup most or all of its losses in the event that the borrower defaults.

Example

For example, say a company seeks a $200,000 loan to expand its operations. If the company pledges the highly liquid marketable securities on its balance sheet as collateral, the lender may grant a loan equalling 85% of the face value of the securities. If the firm’s securities are valued at $200,000, the lender will be willing to loan $170,000. If the company chooses to pledge less liquid assets, such as real estate or equipment, it may only be offered 50% of its required financing, or $100,000.

In both cases, the discount represents the costs of converting the collateral to cash and its potential loss in market value.

Special Considerations

Small and mid-sized companies that are stable and that have physical assets of value are the most common asset-based borrowers.

However, even large corporations may occasionally seek asset-based loans to cover short-term needs. The cost and long lead time of issuing additional shares or bonds in the capital markets may be too high. The cash demand may be extremely time-sensitive, such as in the case of a major acquisition or an unexpected equipment purchase.

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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.

Understanding Asset Financing

Asset financing differs considerably from traditional financing, as the borrowing company offers some of its assets to quickly get a cash loan. A traditional financing arrangement, such as a project based loan would involve a longer process including business planning, projections and so on. 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 not uncommon.

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.

The Difference Between Asset Financing and 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, when an individual borrows money to buy a home or 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 and sell it in order to pay off the amount of the loan. The same concept applies to businesses buying assets. 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. So the company is not purchasing a new asset, but using its owned assets to make up a working cash flow shortfall. If, however, the company goes on to default, the lender can still seize assets and attempt to sell them to recoup the loan amount.

Secured and Unsecured Loans in Asset Financing

Asset financing, in the past, was generally considered a last-resort type of financing; however, the stigma around this source of funding has lessened over time. 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 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 pledged 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. As a result, secured loans usually have a lower interest rate, making them more attractive to companies in need of asset financing.

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What Are Examples of Current Assets?

There are five main categories of current assets.

In order of most to least liquid, here is a list of current assets:

1. Cash and Cash Equivalents

Cash and cash equivalents are the most liquid of assets, meaning that they can be converted into hard currency most easily.

Cash of course requires no conversion and is spendable as is, once withdrawn from the bank or other place where it is held.

Cash equivalents are any type of liquid securities that are not in the form of cash currently, but that will be in the form of cash within a year.

US Treasury bills, for example, are a cash equivalent, as are money market funds.

2. Short-Term Investments and Marketable Securities

Similar to cash equivalents, these are investments in securities that will provide a cash return within a single year.

These types of securities can be bought and sold in public stock and bonds markets.

In the case of bonds, for them to be a current asset they must have a maturity of less than a year; in the case of marketable equity, it is a current asset if it will be sold or traded within a year.

Marketable equity can be either common stock or preferred stock.

3. Prepaid Expenses

Prepaid expenses are funds that have been spent preemptively on goods or services to be received in the future.

They are not technically liquid because they don’t earn a company money; however, they are listed among a company’s current assets because they free up capital to be used later.

Payments to insurance companies or contractors are common prepaid expenses that count towards current assets.

A company can also choose to prepay rent it owes on buildings or real estate; however, only one year’s worth of that prepaid rent counts towards current assets.

If a company elects to pay for, say, three years of rent in advance, then the remaining 24 months of rent are not counted as a current asset.

4. Accounts Receivable

Accounts receivable are funds that a company is owed by customers that have received a good or service but not yet paid.

As usual, for these funds to be a current asset, they must be expected to be received within a year.

Accounts receivable are usually incurred when buyers pay a company for its products or services with credit.

Paying for a purchase with a credit card, for example, adds to the accounts receivable of the company from which the purchase was made.

If a business sells something to another business, the transaction also usually takes the form of a line of credit, adding to accounts receivable.

Notes receivable are also considered current assets if their lifespan is less than one year.

5. Inventory

Any inventory that is expected to sell within a year of its production is a current asset.

Inventory is the least liquid of all current assets because unlike short-term securities, which will always pay within a year, and accounts receivable, which a customer is obligated to pay, inventory must be actively produced and sold in order to convert into cash.

Likewise, not all inventory can reasonably be expected to sell within a single year; heavy machinery, particularly specialized machinery like airplanes or industrial equipment, may sit around in storage for a while before finding a buyer.

Inventory that is purchased by consumers and moves quickly is known as fast moving consumer goods, or FMCG, and is the primary type of inventory that also falls under the category of current assets.