What is Asset Financing?
Asset Financing refers to an provision of loan based on the financial strength of the organization by mortgage or hypothecation of balance sheet assets which includes land & building, Vehicles, Machinery, Trade Receivables as well as short term investments where assets amount is decided into regular payment intervals of the unpaid portion of the asset along with interest.
Therefore, we can accurately say it is the practice of 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. It can provide a secure and easy way of getting working capital for your business.
Asset financing is used in two ways: to secure the use of assets and to secure funding from a loan. Both provide financial flexibility for a company by increasing short-term funding and working capital. More companies can qualify for asset financing compared to traditional financing since the assets are used as collateral.
What are Asset Financing Companies ?
Asset Finance Company (AFC) : An AFC is a company which is a financial institution carrying on as its principal business the financing of physical assets supporting productive/economic activity, such as automobiles, tractors, lathe machines, generator sets, earth moving and material handling equipment’s, moving on own power and general purpose industrial machines. Principal business for this purpose is defined as aggregate of financing real/physical assets supporting economic activity and income arising therefrom is not less than 60% of its total assets and total income respectively. It is a type of NBFC.
What is a Non-Banking Financial Company (NBFC)?
A Non-Banking Financial Company (NBFC) is a company registered under the Central Monetary Authority of a nation, engaged in the business of loans and advances, acquisition of shares/stocks/bonds/debentures/securities issued by Government or local authority or other marketable securities of a like nature, leasing, hire-purchase, insurance business, chit business but does not include any institution whose principal business is that of agriculture activity, industrial activity, purchase or sale of any goods (other than securities) or providing any services and sale/purchase/construction of immovable property. A non-banking institution which is a company and has principal business of receiving deposits under any scheme or arrangement in one lump sum or in installments by way of contributions or in any other manner, is also a non-banking financial company (Residuary non-banking company).
What does conducting financial activity as “principal business” mean?
Financial activity as principal business is when a company’s financial assets constitute more than 50 per cent of the total assets and income from financial assets constitute more than 50 per cent of the gross income.
What are the functions of NBFCs?
- NBFCs are doing functions similar to banks. NBFCs lend and make investments and hence their activities are akin to that of banks; however there are a few differences as given below:
- NBFC cannot accept demand deposits;
- NBFCs do not form part of the payment and settlement system and cannot issue cheques drawn on itself;
- deposit insurance facility of Deposit Insurance and Credit Guarantee Corporation is not available to depositors of NBFCs, unlike in case of banks.
How does Asset Financing Work?
There are two methods 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.
What types of assets can I finance?
There are two main types of asset:
- Hard assets: These are physical, high-value items, including vehicles, such as company cars, tractors and machinery, engineering and manufacturing equipment, and even buildings and premises.
- Soft assets defines the less durable assets, inclusive of IT hardware, software packages, catering equipment, office furniture and security systems, which may have little saleable value by the end of the finance agreement.
You can use asset finance to buy, lease, or borrow against a number of high-value items. Asset finance companies will want to know that the asset is:
What are the various types of Asset Financing?
There are basically Five Types of Asset Financing. They are discussed below:
1. Hire Purchase
The borrower will make payments to the lender to pay off the asset over time. At such time, the asset is owned by the lender until the loan is paid off. Once the final payment is made, the borrower will be given the option to purchase the asset at a nominal rate.
The asset’s value is shown on the lessee’s balance sheet as a liability or an asset during the agreement period. In contrast, the rent is treated as an expense and debited to the Profit and loss account.
2. Equipment Lease
Under equipment Lease, there is a contractual agreement where the asset owner, i.e., the lessor, permits the lessee to use the asset for a contracted period for which regular rentals are to be paid. Equipment leases are popular options 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.
Under this arrangement, the asset is taken for a short period, not for the entire working life. Here, the lessor will take back the asset at the end of the agreement, and maintenance responsibility in some cases lies with the lessor or otherwise, the lessee is responsible. The asset is not shown on a balance sheet for a nominated period, and the payment is charged in the profit and loss account.
Here, the ownership of equipment remains with the lessor, and in case of infringement of any terms of the agreement, the lessor has the right to cancel the lease agreement.
3. Operating Lease
An operating lease 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. 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.
4. Finance Lease
Here, all rights and the obligations of the owners are transferred to (the business) Lessee and for any duration. Lessee is wholly responsible for the maintenance of the asset during the agreement period. The borrower holds responsibility for the maintenance of the asset during the life of the lease. The asset’s value is shown on the lessee’s balance sheet as a liability or an asset during the agreement period. In contrast, the rent is treated as an expense and debited to the Profit and loss account.
5. Asset Refinance
This option varies significantly from other asset financing options, under asset refinancing, assets like vehicles, buildings, etc., are used to secure a loan. If the loans are not made, the lender takes the asset that was secured against the loan to cover up its given amount. The amount borrowed depends on the value of the asset. Sometimes, Asset-backed lending is used for debt consolidation.
Asset refinance is used when a business wants to secure a loan by pledging the assets they currently own as collateral. 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.
As you secure a loan against an asset your business already owns, which might be a vehicle, piece of equipment or even business premises, to release the cash your business needs. With asset refinance, lenders will base their offer on the equity you hold in that asset. This means that, unlike a business loan, you can unlock cash from physical assets you only partly own.
The asset you are refinancing must be physically removable to be considered security for your loan. How much you can borrow depends on the value of the asset.
Once the refinancing has been agreed, you pay the provider in instalments over an agreed period, with interest on the loan. If you can’t keep up payments on the loan, the lender will reclaim the asset to get back what is owed.
What are the benefits of Asset Financing?
- The loan using asset financing is easy to obtain compared to traditional bank loans.
- Minimal upfront costs for high-value items.
- Payments are fixed, which helps long-term budgeting.
- Most of the agreements in the case of asset financing have a fixed interest rate which is advantageous for the person borrowing the money.
- In the case of asset financing, the payment gets fixed, which makes it easy for the companies to prepare and manage their budgets and cash flows.
- If the person fails to repay the amount, it leads only to the loss of the assets and nothing more.
- Lender may take care of expensive servicing and maintenance.
- The risk of depreciation and the responsibility for replacing the item if it stops working before the end of the term may fall to the provider.
- Easy access to crucial business capital you would spend on the asset elsewhere.
- It’s an alternative to other typically higher-interest forms of lending, such as overdrafts and bank loans.
- You can mostly access leasing and hire purchase whatever your sector, location, size or age of the business.
What are the disadvantages of asset finance?
- In the case of asset financing, the companies even keep the important assets required for running the business for taking the loan, which puts them at the risk that they can lose important assets that they need for running their business.
- Damages that are not covered by maintenance or servicing may not be covered under your finance agreement, leaving you with the option of paying for it or taking out insurance to cover it.
- If you miss a payment or default on the loan, the equipment may be taken back by the lender. This could cause problems if it is crucial to your business operations.
- Leasing finance or a hire contract may mean you pay for an item you may end up never owning.
- Asset financing is not short-term as most providers do not consider terms of less than a year.
- It can be more expensive, long-term, than buying an asset outright, and you may have to make a deposit or advance payment.
- The value of assets against which the loan is secured can vary in the case of asset financing. There is a possibility that the asset kept as the security is valued at a lower amount.
- As the assets are kept as the security in asset financing, this method is not that effective for securing long-term funding by any business.
- The provider will carry out credit checks when you apply for finance, which may affect your credit report, if to many searches are done in a short space of time.
How long can I have asset finance for?
It will usually depend on the asset’s operational lifetime, especially if you’re securing specialist equipment. It tends to be between one and seven years, but the provider may offer shorter or longer terms.
How much asset finance could I get?
Amounts accessible are dependent on the lender, it’s possible to secure a lease for as little as $1,000. The most expensive agreement you’re likely to find will be around $10 million. The lender will need to be satisfied that your business can afford the repayments before they approve the purchase or loan, and bear in mind that sometimes your business will need to have a minimum annual turnover.
To determine if Is asset finance right for your business, some factors should be considered. The business owner or Manager must be able to decide from a consideration of those points.
These factors include; type of business and the assets you want to fund, length of contract being offered, what happens to the asset at the end of the contract, and that the repayments will not put stress on your working capital. Like most business funding options, you’ll need to make sure you can make the regular repayments on time, and show evidence of that to the lender when you apply. It’s also worth being aware of the pros and cons of the specific type of finance agreement you’re choosing.
A careful consideration of the above will guide the Business man or woman toward fruitful decisions.