Understanding Asset Finance

Asset finance may seem quite confusing for those who have never quite have had any exposure to the term and its definition as there is a tendency towards jargon used by various industries.

There are numerous questions regarding asset finance and the exact definition along with the way it works, and what it means to businesses who make use of asset finance.

Asset finance can plainly be defined as a type of finance which is utilized by various businesses to acquire any equipment that they need for operations and which will enable them to grow and expand as a business.

Obtaining asset finance usually involves the payment of regular charges for the use of the asset over a certain amount of time without the business having to buy the asset at full cost immediately.

When looking at asset financing in detail, it involves the use of the business’ balance sheet assets which includes short term investments, inventory, and the accounts the business receives to borrow money or apply for a loan from a provider.

The business will then be liable to provide the provider with a security interest in the assets to enable the business to obtain a cash loan against those assets.

This differs greatly from obtaining traditional financing as it involves a much longer process which is a lot more intricate and inclusive of business planning, projections, and several other factors to obtain traditional financing.

Asset financing, on the other hand, is more often by the borrowing business in need of short term cash loans or working capital who pledges the accounts they received and although they pledge assets, these assets can still be used during the loan process and period.

The process involved with obtaining Asset Finance

Plainly put, a business applies for asset finance through a loan provider and selects the asset that it would like to acquire. The loan provider pays for the asset and it is provided to the business according to a contract that has previously been agreed upon.

Through this, the business has access to the asset quickly without having to pay a large sum of money upfront for the asset, which would otherwise have affected the cash flow or capital of the business.

As per the agreement between the business and the loan provider, payments are spread over a term with monthly payments being required, but this may vary depending on the agreement between the business and the loan provider.

Some borrowers make weekly, monthly, and even yearly repayments with others even having their repayment scheduled around seasonal variability. This provides businesses with a lot more flexibility than a commercial bank loan would have provided.

Business profitability and Asset Finance

Despite the lack of profitability of a business, asset finance can be used especially by businesses who are just starting up and have not yet had a lot of time to establish capital or consistent cash flow.

As long as the business can show that they will be able to make repayments as agreed and on schedule. This is also where collateralization plays a great role as businesses provide assets as collateral for securing a loan.

In a lot of cases, businesses are also required to provide a business plan which the loan provider considers which includes how the asset to be acquired will be used to positively impact the turnover of the business.

The differences between Asset Finance and Commercial Bank Loans

A lot of small businesses may turn towards their banks should they need capital which will allow them to purchase new machinery, equipment, and an array of other assets needed to either expand on business and operations, or to maintain such.

Despite this avenue, a lot of businesses may instead turn towards asset financing for an array of reasons, especially where some businesses do not have a good, or exiting, credit record.

When differentiating between these two funding resources, it is important to consider some of the differences between them, namely:

Security

When considering asset finance, it is imperative to note that in order to make use of this option, there has to be some form of security which is provided over the equipment, or asset, which is being acquired.

When using asset finance, the asset is the only physical security for the bank loan whereas when taking a commercial loan with a bank, the asset may be secured over property, term deposits or by way of a floating charge over the entire business.

There is a lot less restriction where asset finance is concerned when compared to a commercial bank loan.

Terms

The period in which the business can repay the loan provider can range from two years to five years, and in some cases, it can even be extended to seven years.

Where commercial banks are concerned, there is a set repayment term which may contain the overall interest cost which is for the life of the loan.

Structure

Asset finance provides a repayment structure facility which is significantly more flexible, and it reflects the annual cash flow of the business which consists of both low and high income periods during the year.

It should however be noted that the facility is, in most cases, structured with equal repayments and this may result in a residual payment, otherwise also known as a ‘balloon’ payment which lowers monthly payments.

Asset Finance versus Asset-Based Lending

Essentially both asset financing and asset-based lending refer to the very same thing but there is a notable difference as with asset-based lending, the borrower uses a loan to either buy a home or a car with the asset serving as collateral.

Should the loan terms not be met and the asset, the car or home, is not repaid within the set time period, it falls into a default and the loan provider is within its rights to seize the asset and sell it in order for the loan amount to be fully paid.

In asset financing, the same concept applies, as long as other assets are utilized to help the business qualify for, and pay off, the loan, they will not be considered as direct collateral on the amount of the cash loan.

Where asset-based lending is more used by individuals, asset financing is used more frequently by businesses in borrowing against the assets which they already physically own.

Some of the assets that these businesses offer as collateral include:

• Accounts receivable
• Inventory
• Machinery
• Buildings, and
• Warehouses, amidst other things.

Asset financing is done over much shorter terms than that of asset-based lending, and it is mainly used when a business needs cash to pay wages, or to purchase raw materials. It is an easy, secure option for businesses to obtain quick cash for operational or growth purposes.

There are, however, the same strict loan repayment requirements which involves the business going into default.

Should this happen, the loan provider reserves the right to seize the assets that were put down as collateral and attempting to sell them to recoup the loan amount which results in substantial losses for the borrowing business.

Collateralization overview

This is the process where an asset is used to secure a loan, and should the loan be defaulted by the borrowing business; the loan provider is within its rights to seize the asset and attempt to sell it to offset any loss incurred.

By collateralizing assets, the loan provider has sufficient levels of reassurance against the risks involved with defaulting. In addition, it also helps borrowing companies to obtain loans should they have a lack of credit history, or a poor history.

These collateralized loans often have lower interest rates than loans which are unsecured as they provide the loan provider with some assurance that they will not be at a complete loss should the borrowing business default by not being able to make repayment.

The types of financeable assets

Historically speaking, any assets that are either durable, identifiable, movable, and sealable, or more commonly referred to in the abbreviation ‘DIMS’ can be financed.

Due to the evolution of the asset finance industry in recent years there are a lot more assets which can be financed in a wider cross section of lenders which will use either one or more of the requirements indicated in the ‘DIMS’.

There are two categories within which assets fall namely ‘Hard’ and ‘Soft’ Assets. Hard assets often have unique identifiable marks on them, such as machinery, which has either a chassis or a serial number.

Despite new or used, equipment and machinery can both be financed. Some ‘Hard’ assets that can be financed include, but is not limited to:

• Motor vehicles
• Light Commercial Vehicles
• Heavy Commercial Vehicles
• Machinery used in agriculture
• Buses and coaches
• Engineering and manufacturing equipment, and more.

Soft assets are items that present a limited re-sale value with the possibility that there is no pre-used or second-hand value that exists.

These items are considered ‘unsecured’ by loan providers and in the financing of soft assets, loan providers provide loans based on the strength of the business in question along with the consideration of any other available securities such as Director personal guarantees.

Some soft assets that can be financed include, but is not limited to:

• Audio and visual equipment
• Catering equipment
• CCTV
• EPOS Systems
• Garage equipment
• Gymnasium equipment, and more.

Different types of Asset Finance

Asset finance can be divided into several forms, but three of the most common principles include finance lease, hire purchase, and operating lease.

Finance Lease

This consists of a leasing agreement where a business can rent an asset over an agreed period of time which does not exceed five years.

The asset appears on the business’ balance sheet during the life of agreement and it is an element of this rental agreement which is treated as a business expense and subsequently passed through the profit and loss account.

The borrowing business remains liable for the maintaining and the insuring of the asset during the life of agreement while the loan provider remains in ownership of the asset until the final repayment amount has been received.

When the borrowing business reaches the end of the lease, there are three options available:

• The asset can be purchased via a third party for a predetermined fee
• The asset can be returned to the loan provider with the borrowing company being liable for the cost of this transferral, or
• The borrowing business may enter into a secondary lease period which will be spread across an agreed amount of time.

Advantages experienced by businesses pertaining to a finance lease include:

• The use of capital goods without incurring large amounts of costs at one, or various, times with purchasing equipment and instead having use of the asset while making monthly or yearly payments.
• Tax benefits due to the payments being deducted as a business expense.
• Leasing is a cheaper source of financing when compared to other sources of financing.
• Technical support is provided by the provider on the leased asset.
• Leasing is inflation friendly as the business is liable for fixed payments despite the price of the asset increasing.

Hire Purchase

With hire purchase, the business can make use of the asset that they are purchasing immediately, albeit over an agreed term while repayment is done through instalments.

When choosing this option, the full value of the asset will appear on the business’ balance sheet along with an element pertaining to the rental which is treated as a business expense which is subsequently passed through the profit and loss account.

When taking this route, the loan provider maintains ownership of the asset until the final payment is received at the end of the agreement. The business has the option of either keeping the asset, or it can be returned.

The advantages of choosing hire purchase include:

• The avoidance of significant impacts of large upfront purchase costs
• Monthly repayments that are manageable and have fixed interest rates
• Tax benefits with interest and charges that can be offset, and
• The ability for the business to remain in control with the rights of ownership being retained by it.

Operating Lease

This type of asset financing is an especially common option for schools and universities as it is a means through which an ongoing equipment investment is supported.

This option is chosen should the equipment financed not be needed for its entire working life and payments subsequently appear on the profit and loss account.

Due to the asset only be kept for a certain and defined period, the value thereof along with its corresponding finance liability will not appear on the balance sheet of the business.

As soon as the agreement has come to an end, the asset is returned.

Other features pertaining to an operating lease include:

• The term of the lease is substantially lower than the asset’s economic life.
• The business has the right to terminate the lease through the provision of a short notice without having to be liable for a penalty.
• The provider provides the technical know-how pertaining to the leased asset to the business.
• The provider is liable for risks and rewards which are incidental to the ownership of the asset.
• The provider is dependent on the leasing of assets to various businesses for the recovery of the investment.

Despite these three types of asset financing being the most common, it is essential to name a few others including:

Fleet Operating Lease

When used by a business when renting vehicles or machinery, the business owns the assets and they must be returned at the end of the contract term. These terms often vary between 12 months up to five years.

The repayments are normally fixed and include the registration, insurance, service, and maintenance of the asset.

Technology Rentals

This type of asset finance is specifically intended for businesses where technology rapidly changes but the business is not willing to use its own working capital to purchase assets and instead involves the renting of technology.

There is a specific technology rental agreement which involves the assets remaining in the ownership of the provider with the business returning the asset at the end of the term, which is normally only three years.

The repayment when making use of technology rentals is flexible to the business’ seasonal cash flow, should this be necessary.

Chattel Mortgage

With this type of financing, the business owns the asset from the outset and the loan agreement between the business and the provider is secured against the asset. The term is normally over five years.

Some of the repayment options include that of the depositing of a large final instalment, or a residual payment, which is more commonly known as a ‘balloon’ payment.

The repayment on this asset financing source is flexible with payments which can be done according to the business’ cash flow seasonality.

Asset Refinance

Businesses can easily free up working capital through the refinancing of an asset which is already in the business’ ownership. This is often applicable to vehicles, equipment, or machinery which was previously financed, with the contract already having been paid.

Refinancing assets can provide the perfect avenue for growth through the exploration of new markets, the expansion and restructuring of business, and the upgrading of premises, machinery, equipment, and more.

In addition, it can provide some stability in paying any existing arrears, the consolidation of debt and reduction of monthly payments along with raising capital should unusual and unforeseen circumstances arise that require immediate attention and capital.

Secure and unsecure loans in Asset Finance

In the past, asset finance was considered as the type of financing that was the very last resort, but thankfully the stigma surrounding it has lessened greatly, with more businesses making use of it in more recent times.

This is predominantly true for small companies and start-ups along with other companies that do not possess a track record or credit rating which would ordinarily allow for the qualification for alternative funding sources.

Two basic loans are provided to such businesses namely secured and unsecured loans. A secured loan is the more traditional avenue where a business can borrow with the prerequisite of pledging an asset against the debt.

The loan provider subsequently considers the value of the asset which is pledged instead of turning towards considering the creditworthiness of the business. This is known as the ‘borrowing base’.

The loan provider may also assess the ledgers and the assets of the borrowing business frequently as asset finance is structured as a revolving loan, and this also involves the continuous valuation of the asset and the loan based on this information.

Should the loan provided not be repaid by the borrowing business, the asset pledged may be seized.

Although assets are often used as means to secure the loan, loan providers may opt to use accounts receivable to back up the loan as they convert to cash a lot easier than having to attempt to sell an asset to make up for losses and repaying the loan.

There is a higher percentage offered on the value of the accounts receivable whereas a lower percentage is offered on physical assets due to it being more difficult to convert them into cash.

When considering unsecured loans, there may not be a collateral asset involved but the loan provider may have a general claim on the assets of the company should the loan terms not be met, and repayment not be made.

In the event that the business files for bankruptcy, secured creditors receive a large portion of their claims, resulting in the interest rate in secured loans being substantially lower than that of unsecured loans, which makes a secured loan a lot more attractive.

What are the pros and cons of Asset Finance?

It is important for businesses to, realistically, consider the pros and the cons when using asset finance to acquire new equipment, and to compensate adequately especially where cons are concerned as they can be substantial, but manageable.

Overview on the pros and cons of Asset Finance

Where asset finance is concerned, there is no one single route that will work for every business, what works for one business, will not work for another, and it is imperative to weigh both the pros and cons in order to make an informed decision.

Pros

When investing in the finance of an asset, it helps businesses with a boost in their cash flow that can lead to further development, expansion, and growth of the business as more working capital can support the business greatly.

There is also a significant amount less risk associated with asset finance as, despite losing the business asset due to inability to make payments, the business will only be at risk of losing the assets that have been put down as collateral.

The period involved with repayment is often quite adequate, allowing businesses to make small repayments instead of having to put down a large lump sum which allows the business to maintain its cash flow.

Furthermore, the agreement pertaining to asset finance is secured on the equipment instead of it being on the business which makes it significantly easier for funding to be secured as the loan provider has some security in the asset itself.

Asset finance is also a quicker way through which an agreement can be made, and the borrowing business can have access to capital, or a new asset which can potentially improve operations, expand the business, and more.

Cons

Should the business be unable to make payment on the asset financed, it risks the loss of valuable assets which were put down as collateral along with losing the financed asset.

In addition, interest rates on the financing will result in the business paying a larger amount back on the asset than what the asset is originally worth.

Why should businesses make use of Asset Finance?

Physical assets are vital to businesses along with being awfully expensive, despite the industry and the sector in which the business operates.

Should something happen to vehicles, machinery, or equipment, there may be operational delays which can be detrimental to the business, and where repairs cannot be done, replacement will be needed immediately so that operations can resume.

It is not always possible for a business to put a large amount of money down to buy new assets, and in a lot of cases, despite having such a large sum, may complicate and compromise the business’ cash flow.

Although purchasing an asset with cash would be more beneficial as it means that the business owns the asset immediately and it does not involve financial contracts or ongoing payments, but this option is not always feasible, or sustainable to any or all businesses.

Asset finance allows businesses’ to obtain new assets without deterring the cash flow of that businesses, and it can be done in a variety of ways suited to the business and how they would more adequately be able to make payment on the asset.

By leasing equipment or buying them through instalments through using hire purchase, businesses are able to retain their capital buffer while having a set of lease repayments which are manageable, predictable, and easy to budget for.

When making use of asset finance, there are also tax and accounting advantages

When should Asset Finance be considered?

This option should, plainly said, be considered by any business as part of the process for purchasing additional equipment.

When taking the benefits, or pros, into consideration along with the capabilities of asset finance, businesses are put in the position to demonstrate how asset finance can support the purchasing plans of the business along with influencing the equipment specification.

Solutions are sought out by buyers which provides value at a predetermined price that they are willing to pay and through asset finance, the cost can be spread adequately, allowing businesses to purchase higher specification equipment.

Asset finance is an imperative option that should be considered earlier in the purchase cycle due to the ability it provides in greater control through the breaking down of the total cost of purchase into payments that are more manageable.

Questions a business must ask before considering Asset Finance

Should a business be in need either of capital or a new asset, or any other items needed for business operations, or growth, it is imperative for the business to minimize any impacts on cash flow that may result from substantial capital purchases.

Knowing which questions need to be asked before selecting the right commercial asset finance solution can save a business a lot of time, and ultimately, money.

Some of the top ten questions that need to be asked before an asset financing solution is chosen includes:

1. How much can the business afford to spend on repayments every month?
2. How much flexibility will the business need with regards to repayments?
3. How soon does the business need the equipment, machinery, or other assets?
4. What is the lifespan of the equipment, machinery, or other assets that the business intends to acquire?
5. Would the business like the option to refinance the asset at the end of the contract?
6. Would the business like to include maintenance costs pertaining to the equipment, machinery, or other assets that in the asset finance contract?
7. Is there rapidly changing technology present in the industry within which the business operates?
8. Will the business want to own the equipment, machinery, or other assets once the end of the contract is reached, or will the equipment, machinery, or other assets be returned?
9. What is the business’ preference regarding the end of the contract; will a lump sum payment be preferable, or not?
10. Which securities will the business need?

Final Thoughts

Asset finance may have had a stigma surrounding it in earlier years as the very last resort when considering funding sources, but with the advent in technology, growing markets, and more business ventures, this has changed significantly.

Businesses are provided with a lot more options in funding which can be used for a variety of purposes but is mostly used for further growth and expansion of the business by being able to build on their existing operations.

By being able to finance assets and saving on having to delve into existing capital and cash flows, businesses have a substantial amount more flexibility, given that the repayment terms are met, and avoidance of assets and collateral assets being seized.