Loans allow a business to achieve maximum cash flow liquidity and can assist them when times are hard—or when it’s time to seize an opportunity. There are different types of lending options, but they can be divided into two types: asset-based and credit-based.
Asset-Based Vs. Credit-Based Lending
Asset-based lending is based on the worth of all a business’ assets. This value fluctuates less, no matter how the business fares or whether the economy rises or falls. For some industries, asset-based loans are a more attractive option than credit-based loans.
Credit-based lending is based on an analysis of a business’ enterprise value. This value can fluctuate with economic changes, making credit-based lending a less stable option than asset-based lending. In the worst cases, a company using credit-based loans may find itself no longer worth enough to secure a loan to restart business after a bad period.
How Asset-Based Loans Work
A lending agency will determine how much of a loan a business qualifies for by looking at the total worth of all its assets. The agency will then advance a percentage of the value of the assets to the borrower.
This differs from asset factoring because the business does not sell its assets to the lending agency. Instead, it borrows against its worth. The assets are used as collateral to secure the loan. If the business cannot make its loan payments, then the lending agency can seize the assets.
When a business wants to acquire an asset-based loan, it is important for it to compare the terms different lenders will offer. Lending agencies can fluctuate on the percentage they offer to advance on the worth of assets, interest rates on the loan, accounting fees, etc. Interest rates on asset-based lending tends to be higher than traditional loans, but lower than unsecured loans.
Who Uses Asset-Based Loans and Why
Businesses that benefit most from asset-based loans or lines of credit are those with many high-value assets. These can include inventory, real estate, raw materials, equipment and tools, and accounts receivable. Business who keep fewer assets on hand may find that they do not qualify for much of an asset-based loan and instead may choose a credit-based loan.
Asset-based lending can work for any business size, but it’s most often used by midsized and larger ones, as they have more assets to be valued. Certain industries are more likely to have assets that increase their likelihood of acquiring asset-based loans. These types of businesses are:
- Certain service companies
Businesses turn to asset-based loans in many situations. Some of these include:
- Businesses that have poor credit histories and cannot secure traditional loans.
- Businesses that have insufficient cash flow to hire new employees or seize other growth opportunities.
- Businesses that cannot pay suppliers or utilities and wish to avoid late payments and the subsequent credit damage.
- Businesses that need money more quickly than the traditional loan application process takes.
Asset-Based Lending Reports
Asset-based lending offers a few special challenges to enterprises that choose it over traditional or credit-based loans. Some of the assets a business possesses change value several times a day. Asset-based lenders require that their borrowers make special reports on such changes on a frequent basis. Reports may need to be filed monthly, weekly, or daily, depending on the business’ credit profile and other financial data.
Asset-based loans and lines of credit offer businesses a way to use their non-liquid assets to create cash flow when needed. This can be helpful in certain situations, but business owners need to be aware of higher interest rates compared to traditional loans.