Also known as Asset based financing or commercial finance, asset based lending (ABL) refers to a specialized method of using accounts receivable, inventory, real estate, equipment and machinery as collateral to provide working capital to companies through term loans. Asset based lending refers to loans taken by companies and backed by the assets of those companies.
That is for instance, if company A takes a loan and uses its assets as collateral, such a loan is an asset based financing loan. Often times, it might be difficult for a company to effectively run its day to day operations especially if said company cannot afford to finance its raw materials hence, such companies require an alternative source of financial income.
The asset based lender finances these raw materials and purchase orders are then made to the lender. Once these orders are filled, payment is then made to the lender and the lender deducts its costs and fees and remits the balance if any to the company.
These loans are taken in order to meet cash flow demands so as to cover its payroll expenses. The loans terms and conditions are dependent on the type and value of the assets being offered as securities. These loans are usually offered at 70% to 80% of eligible receivables and 50% of finished inventory.
What Is Cash Flow Lending: How It Works
On the other hand, cash flow lending is a form of debt financing where banks lend funds to businesses generally for working capital and uses the expected cash flows generated by the borrowing company as the loan’s collateral. It is lending that is often used to finance the day-to-day operations of small businesses.
These loans are unconventional bank loans and as such require even more evaluation of the business’ credit before they are eventually given out. The lender has to evaluate the cash generation capacity of the borrower in order to determine the loan’s terms.
Often times, cash flow lending is usually done by small companies who do not have long credit history but also has significant assets to back a loan or a track record of profitability. As such, more interest is required on these cash flow loans as a compensation for the greater risk being taken. Other times, the lender requires a blanket lien or personal guarantees before the loans can be given out. These loans could often be draining on the income of a business particularly due to the large amounts of interests charged on them.
Cash Flow Lending Vs Asset Based Lending: Differences Explored
Companies whether small or medium scale enterprises or old conglomerates often require alternative funding or borrowed capital to ensure the smooth running of the organization. When it comes to borrowing, business entities have even more options than individuals which therefore mean that care must be taken before taking out credit for your business.
As such, before taking out loans and other forms of debt finance, you as a business owner must have proper understanding of the loan options available as well as lenders.
As a business, you have access to two types of loans which could either be secured or unsecured loans. Secured loans such as asset based lending and cash flow refer to loans which are given out and backed by collateral; unsecured loans such as however hold greater risks as they are not backed by collateral.
Cash flow and asset-based lending are good credit sources for businesses seeking alternative sources of income as they are loans often granted on cash flow and assets of the business. There are however differences between the two forms of debt finance. These include;
The same types of assets are accepted by all lenders as collateral; however, the assets considered essential in an asset based loan are income from accounts receivable, the company’s real estate, equipment and inventory.
This means that as the borrower, you have to agree to the liquidation of your business’ assets should you default on loan payments.
Cash flow lending on the other hand does not require collateral security, rather it is based on the company’s expected income as well as its credit rating.
These two forms of debt financing are not suitable for all types of businesses, cash flow lending evaluates the borrowing company’s credit rating and this is a key determinant to whether or not the business can borrow and just how much can be borrowed. They are suitable for businesses with high credit ratings and documented cash flow.
In the same way, asset based lending is much more suited for borrowers with lower credit rates or cash flow who have substantial assets to back their loans.
These two forms of debt financing have two different focus points. Cash flow lending focuses on the businesses cash flow, that is income and profits, while asset based lending is more focused on the business’ assets over its cash flow. While ADL still considers the business’ cash flow, it is only considered secondary after these substantial business assets.
For businesses that do not have enough cash flow to finance their day to day operations and thus require alternative funding, asset based lending is a viable option, the only condition being that these assets based loans are generally more expensive than cash flow loans.
They cost more than cash flow loans as they include the extra cost of fees and high interest rates.
Cash flow lending on the other hand merely require a business’ credit and cash flow to be on the other side, however, while their high interest rates makes them expensive, they are however still not as expensive as the cost of assets assessments, fees and interest rates of asset based loan financing.