Asset Financing is a type of financing option in which the borrower (businesses) borrow for the purchase of assets.
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Meaning of Asset Financing
Asset financing generally refers to loan availed by companies on the basis of the financial strength of the company. It is used for the growth and expansion of business to save on paying the full value of the asset outright. The asset’s amount is divided into small regular payments along with 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. Rather, 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.
Reason Why Businesses Prefer Asset Financing
With technology and innovations growing in every field, businesses are in constant need of money to purchase new assets. Asset financing is a mechanism to provide business 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 the role of asset financing becomes important.
Types of Asset Financing
Asset Financing includes the following types:
Credit Risk Associated with Asset Financing
Banks and other financial institutions act as lenders in asset financing. Asset financing is relatively safer for the banks and other financial institutions than giving a conventional loan to the borrowers. In asset financing, the lending institutions’ finance is secured by the value of asset financed. Moreover, in most of the cases, the finance value is even secured through collateral security. 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 their seizure; the risk of decline in the value of the asset always looms over their 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, they get regular interest on the lent amount and also they have the right to seize the asset in case of non-payment of principal or interest by the borrower.
Asset financing is a boon to the business. If a business is willing to expand, asset financing is a perfect solution for their financial needs. The businesses now don’t need huge cash in hand before purchasing any new asset; instead, they can just finance it via asset financing. Asset financing is not only beneficial for the borrowers but also to the financial institutions who lend the money, as they get the regular interest and their risk is covered with assets kept as collateral security.1–3