Asset Financing – Meaning, Types, Risk Associated and Differences

What is Asset Financing?

Asset Financing is a type of financing option in which the borrower (business) borrows for the purchase of assets. This financing generally refers to loans availed by companies on the basis of the financial strength of the company. It is useful as it helps for the growth and expansion of business and to save on paying the full value of the asset outright. The asset’s amount is divided into small regular payments and interest for the unpaid portion. The payment obligation and the ownership rights of the borrower change depending on the method of asset financing.

Difference between Asset Financing and Loan

Under asset financing, the lending is not in the form of a conventional loan where the lender gives one single payment to the borrower. Instead, the payment is spread over a period of time. This saves the business from paying one big amount for purchasing an asset in the form of machinery, vehicle, etc.

Asset Financing

Reason Why Businesses Prefer Asset Financing

With technology and innovations growing in every field, businesses constantly need money to purchase new assets. This mechanism provides businesses with the necessary cash flow to meet this need.

Purchasing a new asset in cash can be risky as not all businesses have the required financial capability. Moreover, capital expenditure for buying costly assets can lead to cash flow problems resulting in a shortage of working capital. A working capital crunch can hamper the regular functioning of the business. This is where its role becomes important.

Types of Asset Financing

It includes the following types:

Credit Risk Associated with Asset Financing

Banks and other financial institutions act as lenders in this financing. This is relatively safer for banks and other financial institutions than giving a conventional loan to borrowers. In this financing, the lending institutions’ finance is secured by the value of the asset financed. Moreover, the finance value is even secured through collateral security in most cases. If the borrower fails to repay the borrowed money, the lender can seize the asset and sell the same in the open market to recover the money.

The major concern for the financial institutions is that when the asset is sold in the secondary market after its seizure, the risk of a decline in the asset’s value always looms over its head. To overcome the risk, financial institutions finance the asset considering that the contingent claim is going to arise on the asset, and accordingly, they frame the lending terms. The major benefit to financial institutions is that they get regular interest on the lent amount. They also have the right to seize the asset in case of the borrower’s non-payment of principal or interest.

Conclusion

Asset financing is a boon to the business. If a business is willing to expand, it is a perfect solution for its financial needs. Companies now don’t need massive cash in hand before purchasing any new asset; instead, they can just finance it via asset financing. This is beneficial for the borrowers and the financial institutions who lend the money, as they get the regular interest, and their risk is covered with assets kept as collateral security.



Sanjay Borad

Sanjay Bulaki Borad

Sanjay Borad is the founder & CEO of eFinanceManagement. He is passionate about keeping and making things simple and easy. Running this blog since 2009 and trying to explain "Financial Management Concepts in Layman's Terms".

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