Asset Based Financing
Asset based financing is a quick and easy way for a company to bring in cash for a planned expansion or to simply keep the enterprise afloat. However, asset-based loans come at a price and with heavy penalties for defaulting. Rapidly growing companies seeking funding commonly use this type of lending to meet their short-term cash needs. As its name implies, a company offers up assets as collateral to temporarily increase cash flow. Basically, there are two ways to generate cash using this method: asset-based loans or through what is known as factoring. Prior to the turn of the century asset based financing was available to business, but it was a little known or publicized part of the banking system. For the most part, small business used it exclusively. However the subsequent turmoil of the financing and mortgaging industry, larger corporations have started using the service, too. However, small to midsize business continue to fuel much of the industry's growth.
Not surprisingly, quick and hasty asset based financing decisions often lead to serious trouble, so scrutinize and evaluate any type of loan before signing the papers. Christians should also pay heed to money advice found in the Bible. Start with the book of Romans which offers some excellent and sound advice that, if followed, may prevent frustration, heartache, and the loss of assets and business: let no debt remain outstanding by paying back all that is owed. Quick loans are tempting, especially in times of a financial crisis. But, hastily borrowing money may actually increase the financial burden of a company, not lessen it as hoped. Pledging assets in return for cash loans can have detrimental consequences for failure to repay, and the book of Psalms says that it is the wicked that borrow and then not repay. Therefore, only borrow what can be paid back.
In an effort to protect their own interests, financial institutions turned to asset based financing because business owners pledge their assets to secure a loan from a bank or finance company. That way if a loan does goes into default, a lender isn't left empty handed. Taking the borrower to court is no longer the only recourse. Fortunately, the business retains ownership of the pledged assets. Unfortunately, if the loan goes into default, the bank finance company will seize the assets. Basically, asset based financing was developed for companies with less than perfect credit that have a difficult time getting traditional financing. A competitive market has driven interest rates lower over the past several years, but they are still higher than with traditional bank loans. Rates are often negotiable. Lenders will often look at credit records, length of time in business, and whether or not the assets of applicants are liquid. Accounts receivable and inventory are often used as collateral to secure a loan. Loans based on newer accounts receivable invoices net the business owner a fairly high percentage based on the face value. Up to 75 percent of the value might be forwarded in loans. However, older accounts might still be used but will receive lesser amounts.
Inventory loans work a little differently. Lending institutions that agree to lend money based on inventory, have the option of moving the inventory into a bonded warehouse. That way the goods can be monitored until the debt has been paid off in full. Costs for moving and storing the goods in a bonded warehouse will be passed on to the business owner. Inventory loans may be as low as 30 percent of the face value of the inventory. But, it may also bring in up to 80 percent of the value. Those are the two primary ways of securing asset based financing. However, a third method is available for cash starved or fast growing companies to raise some cash quickly. And that method is called factoring. This option is really simple in design, but carries some heavy risks. Once again reference the Bible. Proverbs says that it is good planning and hard work that will lead a person to prosperity, but taking hasty shortcuts can lead to poverty. As collateral for a loan, a business sells its accounts receivables to a factoring company. The factor, as it is called, will then assume all the risks for collecting the outstanding invoices. Typically a factor will buy the accounts for about 80 percent of the face value. Once the factor collects the balance owed on the loan, the business owner will get the remaining accounts back minus fees and interest rates. One advantage of asset based financing is that small companies can get more cash for expansion or to keep afloat rather quickly. Other services may also be available from the lending institution. The main drawback is the expense because it cost more money to get these types of loans. Using assets to generate cash flow increases the business's cost of obtaining funds and also reduces profits.
One other downside is that customers who discover that their accounts have been sold to a third party might become aware of a company's money woes and take their business elsewhere. Once again the Bible provides sound advice and warns against this very occurrence. "Be not thou one of them that strike hands, or of them that are sureties for debts. If thou has nothing to pay, why should he take away thy bed from under thee?" (Proverbs 22:26-27) As banks have cut back on more traditional lines of credit, collateral based lending has become increasingly more common. According to an industry analysis, asset based financing increased by approximately 11 percent in recent years and finance company loans outstanding to business totaled more than $2 trillion. Smaller and midsized business originally fueled the growth of the industry. But, then larger corporations began to realize the value of asset borrowing and jumped into the market.
Asset Based FactoringMany new businesses turn to asset based factoring as a way to create immediate cash flow for their business needs. Beginning a company is as difficult as it is exciting; many times a person has big dreams that he plans to implement immediately, only to find that he does not have enough money to finance his vision. Or sometimes a business's growth is so unexpected and so quick that the owner needs to expand immediately in order to handle the demand but does not have the cash to do so. Whether a person needs money in order to buy more supplies to meet the customers' needs, or if he is looking to rent extra office space in order to expand the business, having money can mean the difference in being able to accomplish these things or having to wait to do so. Taking advantage of this type of factoring allows a business to turn over invoices to a company and receive payment for them, meaning that the individual is able to go ahead and proceed with plans he may not have had the finances to handle previously.
While the term can sound a bit overwhelming, asset based factoring is a relatively easy concept to grasp. It operates on the assumption that every business, whether it has been around for a couple of months or several decades, has assets in the form of orders that come in. The companies who offer this service to businesses offer to buy invoices at a marginally reduced rate, or for a specific fee that is less than the original invoice amount. The company then takes on the responsibility of collecting payment for the outstanding amounts. And the new business suddenly has a workable sum of cash the owner can use to begin and complete various projects. This type of money advance is not a loan, meaning that in normal circumstances, the money never has to be repaid. The company who purchased the invoices takes on the responsibility of collecting payment. To state the intricacies of asset based factoring simply, it gives a business the opportunity to collect its own money prematurely.
Before striking an agreement with an asset based factoring company, the business owner needs to be well versed in how the fee schedule will affect his money. Some companies charge a certain percentage on the total amount due on the invoices. Others require a flat fee that may be based on a multitude of different variables. Another criterion that these companies use when deciding how much to charge a business is based on when the invoices' balances are due. For those that have a short limit, such as a couple of weeks, the fee is generally lower. Others, some that may not be due for several months, will require a substantially larger fee in order to compensate for the amount of time that the factoring company will be out of the money. Knowing how much taking advantage of this offer will cost the business owner in lost revenue is an important thing to consider before proceeding with selling the invoices.
One important thing to discuss with the asset based factoring company before a business owner sells some of his assets is whether the owner is liable for the original balance if the invoices are not paid. If a customer has purchased some products, or hired the business to complete a specific service, depending on the business, many times the work or product will be completed or delivered, and an invoice will be drawn up. Customers typically have a set amount of time to pay the balance due. Unfortunately, there are dishonest people in the world who will promise payment without ever intending to settle their accounts. The Bible clearly forbids handling matters in such a way; "Ye shall not steal, neither deal falsely, neither lie one to another" (Leviticus 19:11). These admonishments, however, do not always make a difference to those seeking to get something for nothing. While, hopefully, this will not be a continuing problem for the business, an entrepreneur must expect that this will happen at least occasionally.
So what happens if one such customer's invoice was in the batch that was sold during the asset based factoring? Different companies will vary on their policy in regards to this. Some state, in the written agreement, that should customers not pay for the work or product, that the business must reimburse the charges. Obviously, should this occur, it could cause significant problems for the business owner later on; chances are, the money that was advanced off the invoice will have already been spent, and the owner will have to pay the charges out of his company's profits. Other companies do not make this requirement of the business owner; they will bear the burden of liability should the consumer refuse to pay the bill. This means that the business owner does not have to worry about the invoices again once they leave his hands.
Deciding to take advantage of asset based factoring can be an extremely wise decision in order to help a business out of a tight spot. This can be done one time only, or can be used on a continual basis, as a way for the business to consistently collect on invoices before they are actually due. As with any important business decision, the owner needs to weigh the pros and cons, deciding if pursuing asset based factoring is the best fit for the business's needs. If the owner decides that doing so is the best course of action to ensure the success of his business, then he should research different companies, figuring out which ones offer rates and stipulations that best suit his needs. By having the freedom to liquidate some assets, a business owner can see his dreams for a company come to fruition without having to wait for sometime in the distant future.