Asset Financing

Asset financing is a way for businesses to raise money or acquire equipment by using assets as the basis of the funding. It covers two broad situations: paying for new assets such as machinery, vehicles or technology over time instead of up front, and borrowing against assets the business already holds, such as its receivables or inventory. In each case the lender or finance company relies mainly on the value of the asset, rather than only on the borrower's overall credit, to protect itself.

Asset financing includes leasing, hire purchase, equipment loans and forms of asset-based lending. It is widely used by small and medium-sized businesses that want to preserve cash, by airlines and shipping companies, and by firms upgrading technology. It is distinct from unsecured business loans and from equity financing, where investors buy shares.

A bakery needs a new oven costing $30,000 but does not want to empty its bank account. A finance company buys the oven and lets the bakery use it in return for monthly payments. If the bakery stops paying, the finance company can take the oven back. Because the oven protects the lender, the bakery may get the deal even if it could not get an ordinary loan.

A business can also use what it already owns. A wholesaler with lots of unpaid customer invoices can borrow against them, getting cash today rather than waiting weeks to be paid.

• Hire purchase. Under a hire purchase agreement, the business pays instalments and owns the asset after the final payment.
• Finance lease. The finance company owns the asset and leases it to the lessee for most of its useful life; the business bears most of the risks and rewards of ownership.
• Operating lease. A shorter lease in which the asset returns to the lessor at the end, common for vehicles and IT equipment.
• Equipment loan. A secured loan to buy an asset, with the asset as collateral.
• Sale and leaseback. A business sells an asset it owns to a financier and leases it back, releasing cash while keeping use of the asset.
• Receivables and inventory finance. Borrowing against invoices through factoring or invoice discounting, or against stock through inventory financing.

The financier assesses the asset's value, expected life and resale market, as well as the borrower's ability to pay. Agreements typically set an advance rate, a term matched to the asset's useful life, and a schedule of payments that may include a deposit and a final balloon payment. Pricing reflects interest rates, the asset's residual value at the end of the term and the credit risk of the borrower. Assets that hold value well and are easy to resell, such as standard vehicles, usually attract better terms than specialised machinery.

Accounting for leases changed significantly with IFRS 16, effective from 2019, and the US standard ASC 842. Under IFRS 16, lessees bring almost all leases onto the balance sheet as a right-of-use asset and a lease liability, ending much of the off-balance-sheet financing that operating leases once allowed. US GAAP also requires lessees to recognise most leases on the balance sheet but keeps a distinction between finance and operating leases for expense recognition. Under hire purchase and equipment loans, the business records the asset and the borrowing and charges depreciation over its life.

Asset financing lets businesses spread the cost of expensive items over the period they generate revenue, preserving working capital for day-to-day needs. It can be easier to obtain than unsecured credit for small and medium-sized enterprises, and leases can include maintenance and upgrades. Some lenders now accept digital assets as collateral, through crypto-backed loans, applying the same logic of lending against asset value with conservative loan-to-value ratios to cope with price swings.

Over the full term, asset financing can cost more than buying outright. If the business falls behind on payments, it can lose the asset, which may disrupt operations. Long contracts can lock firms into outdated equipment, and early termination fees can be high. For lenders, the main risks are that the asset is worth less than expected when repossessed, or that it is hard to recover, damaged or difficult to sell. Careful review of terms, total cost and end-of-term options is important before signing.