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What You Need to Know about Asset-Based Financing

Asset-based financing, though once considered a financing option of last resort, is now a popular choice for companies that are highly leveraged with debt or do not have a long credit track record for traditional financing.

The main difference between asset-based financing and other traditional types of lending is that asset-based financing is secured by an asset like trade receivables, inventory, or property and equipment.  Securing assets for business loans or revolving lines of credit can provide smaller companies with great advantages to get more cash than they could otherwise from traditional bank financing.  If your company is considering obtaining a revolving line of credit or other types of financing, then here are a couple things to educate yourself about the basics of asset-based financing.

Revolving credit lines can be a great way to bridge the timing conflicts of cashflow and are commonly used by retailers, wholesalers, distributors, and manufacturers.  In this arrangement, the lender will set a maximum line of credit that is based on the company’s trade receivables and/or inventory.  The benefit in placing the borrower’s assets as collateral is that the borrower will receive a higher amount of maximum credit with a lower interest rate.  Keep in mind that only eligible assets are used in determining the borrowing limit of the asset-based agreement.  For instance, any receivables over 90 days outstanding or related party receivables may be excluded from the borrowing limit calculation. Eligible inventory assets generally include finished goods and marketable raw materials, while work-in-process and slow moving inventory will be deemed as ineligible.

In most cases, the asset-based lending agreement will give the lender control of the customers’ cash receipts and may require the setup of a lockbox.  A lockbox is usually created at the bank where the borrow does business and the borrower’s customers are instructed to send their payments to the lockbox address.  As payments are received, the money is applied against the loan or revolving credit line balance.

As with any type of financing, it is important to shop around for favorable interest rates and educate yourself about the basics of asset-based and traditional financing options before negotiating financing terms.  In the end, short term liquidity is important in every growing business and asset-based financing can be one way to stay afloat in this turbulent economic environment. 

Danny Oertle