Asset-Based Financing – Basics

For companies experiencing temporary cash shortages, asset-based financing may be an alternative that makes sense as a viable way of meeting its cash shortfalls. With this method of financing, a cash-strapped business can use the assets that they have to overcome its cash flow shortages.

As noted by FinWeb, there are two primary means of asset-based financing, as follows:

1) asset-based loans

2) factoring.

As FinWeb explains, to obtain an asset-based loan, a business must apply for a secure loan from a lending institution, collateralized by pledging one or more assets. Asset-based loans are used generally by companies with somewhat spotty credit. As such, the fees and interest rates for these loans will typically be higher than market prices. Accounts receivable and business inventory are the most common assets used as collateral, but any asset might be accepted by the lender.

 Secondly, there is a method of asset-based funding known as factoring. It is often used by rapidly-growing companies in need of immediate cash. Using this process, the business will actually sell its accounts receivable to a factoring company for cash (as opposed to pledging them as collateral for an asset-based loan). For newer invoices, the company could receive up to eighty percent of their value up front. The factoring company assumes all credit risk for the outstanding accounts.

The principal disadvantage of asset-based financing is its expense. Using assets to bolster cash flow increases a business's cost of funds, thereby significantly affecting its bottom line: the profits.

REVOLVING LINES OF CREDIT (REVOLVERS)

As noted by the Journal of Accountancy, a revolver is a line of credit established by the lender for a maximum amount. The line of credit typically is secured by the company’s receivables and inventory. It is designed to maximize the availability of working capital from the company’s current asset base. The borrower grants a security interest in its receivables and inventory to the lender as collateral to secure the loan. In most cases, lenders require personal guarantees from the company’s owners.

The security interest creates a borrowing base for the loan. As receivables are collected, the money is used to pay down the loan balance. When the borrower needs additional financing, another advance is requested. The borrowing base consists of the assets that are available to collateralize a revolver. It generally consists of eligible receivables and eligible inventory.

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