Asset based lending is a financing option that puts assets, usually in the form of accounts receivable and inventory, up as collateral as the main form of repayment for the loan instead of cash flow or business earnings. In asset based lending, it is the quality of the collateral that is important, not so much the financial strength of the borrower. This is in contrast to the traditional bank loan which looks at earnings for operations to decide debt service capacity, though sometimes assets are considered as a secondary source. Asset based loans advance funding depending on an agreed percentage of the assets’ value, typically 70 to 80 percent of qualified receivables or 50 percent in finished inventory.
What Qualifies as Collateral
Assets that can be used as collateral can be any raw material used for production, whether it be land, inventory, or machines. Only complete items count as assets and works-in-process are not acceptable forms of collateral.
How to Acquire an Asset Based Loan
Asset based financing options are offered by a vast array of financial companies. Securing a loan comes down mostly to having good financial statements, a quality reporting system, commonly sold inventory, and a solid customer base. This type of information shows the lender the company is prepared to take on the loan and pay it back in a timely manner.
Advantages and Disadvantages
Asset-based loans are particularly useful to companies, whether they are working in manufacturing, distribution, or service related fields, if they have leveraged balance sheets. Many companies seek this type of financing if they have exhausted all other options in order to meet seasonal needs, when they are growing quickly, undercapitalized, or to finance acquisitions. Many times these type of loans have lower interest rates as the financier will seize and liquidate collateral in the event of a default. The financial company may ask customers to pay them directly, placing the cash flow in third party control, which can be an uneasy situation.
Securing an asset based loan usually takes three to four weeks during which pre-screening, underwriting, and a term sheet are drawn up. Financial information, including deposit for expenses or an audit deposit, are collected and the application must be submitted for approval by a loan committee.