Definition of asset financing

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What is asset finance?

Asset financing refers to the use of assets on a company’s balance sheet, including short-term investments, inventory, and accounts receivable, to borrow money or obtain a loan. The company borrowing the funds must provide the lender with security over the assets.

Understanding asset finance

Asset financing differs significantly from traditional financing, as the borrowing company offers part of its assets to get a cash loan quickly. A traditional financing arrangement, such as a project-based loan, would involve a longer process including business planning, projections, etc. Asset financing is most often used when a borrower needs a short-term cash loan or working capital. In most cases, the borrowing company resorting to asset financing pledges its trade receivables; however, the use of inventory assets in the borrowing process is not uncommon.

Key points to remember

  • Asset financing allows a business to obtain a loan by pledging the assets on the balance sheet.
  • Asset financing is generally used to cover a short-term need for working capital.
  • Some companies prefer to use asset financing instead of traditional financing, as 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 finance and asset lending

At a basic level, asset finance and asset lending are terms that basically refer to the same thing, with a slight difference. With asset loans, when an individual borrows money to buy a house or a car, the house or vehicle serves as collateral for the loan. If the loan is not repaid within the specified time, it falls within the fault, and the lender can then seize the car or house and sell it in order to pay off the loan amount. The same concept applies to companies that buy assets. With asset financing, if other assets are used to help the person qualify for the loan, they are generally not considered a direct guarantee on the loan amount.

Asset financing is typically used by businesses, which tend to borrow against the assets they currently own. Accounts receivable, inventory, machinery and even buildings and warehouses can be offered as collateral for a loan. These loans are almost always used for short-term financing needs, such as cash to pay employees’ salaries or to purchase the raw materials needed to produce the goods sold. Thus, the company does not buy a new asset, but uses its own assets to fill a cash shortage. If, however, the business defaults, the lender can still seize the assets and attempt to sell them to recover the loan amount.

Secured and unsecured loans in asset finance

Asset finance, in the past, was generally viewed as a type of finance of last resort; however, the stigma surrounding this source of funding has diminished over time. This is mainly true for small businesses, startups and other businesses that do not have the history or credit rating to qualify for alternative sources of finance.

There are two main types of loans that can be granted. The most traditional type is a secured loan, in which a company borrows, pledging an asset against the debt. The lender takes into account the value of the pledged asset instead of looking at the creditworthiness of the business as a whole. If the loan is not repaid, the lender can seize the asset that has been pledged against the debt. Unsecured loans do not specifically imply guarantees; however, the lender may have a general claim on the assets of the business if the repayment is not made. If the business goes bankrupt, secured creditors usually receive a greater proportion of their claims. As a result, secured loans generally have a lower interest rate, which makes them more attractive to businesses in need of asset financing.

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