Asset-based lending is a form of asset finance that allows a business to release cash from its existing assets. If you’re struggling to meet loan payments on a particular asset that you already own, you can sell this asset to an asset finance company for a lump sum. You’ll then lease the asset from the provider over an agreed period.
If your business has a range of assets, such as property or vehicles, you can use these items as security, or collateral, to secure a reasonably significant business loan, depending on the value of your assets. This method is known as asset refinancing. Similar to a mortgage, businesses typically undertake asset-based loans by putting up physical assets as security to gain access to a loan from an asset finance company.
Hire Purchase
Hire purchase (HP) is a form of asset finance where firms can acquire assets through an asset finance provider, who agrees to purchase an asset that the business needs, outright. The company then spreads the cost out over time in instalments paid to the asset finance company. Ownership is transferred to the business at the end of the leasing period, once all instalments have been paid.
Hire purchase is an excellent option if you don’t have the current capital to make the purchase. It’s a fixed-rate loan with low-interest rates, ideal for assets that you need long-term. You can pay a large initial payment followed by smaller amounts, making it one of the more flexible asset finance options. The payment term is usually 1-5 years, so if you only need the asset in the short-term, you should consider a less risky option, such as leasing.
At the end of the leasing period, you’ll need to pay a final fee, which is a percentage of the asset’s value. In accountancy terms, the asset is treated as if you own it during the lease period, meaning it will appear as an asset on your balance sheet. The hire purchase amount shows as a liability on the balance sheet, which reduces as the firm makes each HP payment. You therefore need to consider whether the asset will depreciate over time, as while your asset will have less value each year due to depreciation, your liability remains the same.
A significant disadvantage of asset finance is that you don’t officially own the asset until the end of the lease-period, meaning you’re unable to make any modifications to the purchase until this time has elapsed. If you need autonomy over the asset, consider other forms of finance.
Finance Lease
A finance lease is a favourable option for companies that don’t have the capital to purchase necessary assets, where companies only have use of the assets for a limited period. As with hire purchase, a finance provider agrees to purchase an asset. However, instead of paying an upfront fee and paying back the full value of the asset, the company leases the asset over a set period, covering only the value of the asset within that period.
The main difference with hire purchase is that the business will never own the asset. In the case of a finance lease, the asset finance provider intends to sell the asset at the end of the lease period. In some cases, the finance company may offer the business a portion of the sale value of the asset.
A lease is suitable for more substantial assets that your company needs for a limited term. As you don’t technically own the asset, you don’t need to list it on your balance sheet. This means you can offset your rental costs for property or land against your profit, which can be a significant tax benefit.
Operating Lease
Operating leases are a preferable option to lease equipment, as the lease company takes care of the maintenance. The rental agreement also includes a set term, which is useful when a business may not need an asset for its full usable life. You only pay for the value of the asset over the time of your rental agreement, which is usually cheaper than paying for the full value of the item, as with a finance lease.
As with a finance lease, the asset won’t appear on your balance sheet, meaning you can offset your rent against your profit. At the end of the term, the business can either choose to renew the lease or return the asset. During the lease period, a company has full access to the asset, meaning you’re responsible for insurance and maintenance costs.
Summary
Asset-based lending allows businesses to release cash from existing assets. The company sells an asset to a finance provider for an agreed amount and then pays back this lump sum in the form of a lease, making regular payments over an agreed period. The company recoups the purchase cost and interest. This form of asset finance is useful if a company cannot keep up with maintenance costs or loan payments on a valuable asset.
