Guide to SME Asset Based Finance

Asset based finance is a specialized method of providing structured working capital and term loans that are ‘secured’ by receivables, real estate, inventory, machinery, and equipment. Asset based funding can be used to support startup companies, refinancing existing loans, financing growth, etc.

This article helps SME businesses to identify and choose the most suitable type(s) of asset based finance (depending on the nature of the business, how much funding is demanded, what the money is needed for and when it will be required), from the range of options available:

Factoring can be used to raise capital by borrowing money against unpaid invoices (it’s only available to businesses that sell products or services on credit to other businesses). Factoring involves selling invoices to a factor. The factor pays an advance (typically up to 80%) on all approved invoices. The factor will then manage the sales ledger of the business and collect money owed by its customers. Once a customer settles an invoice with the factor, the factor will release the remaining balance (less any fees).

In recourse factoring, the factor does not risk bad debts and can reclaim the money advanced if a trade debtor does not pay.

Invoice discounting is a similar way of drawing money against invoices, but the business retains control over the administration of its sales ledger. Banks (discounters) have strict requirements regarding the quality of sales ledger monitoring.

Export factoring can be used to support international sales. In this case, factors work with an agent overseas to collect payments in the country to which the business is exporting. (Careful consideration is advised if given a choice of which currency to be paid in. If being paid in the local currency, it may be worthwhile investing in F/X protection against fluctuations in the exchange rate).

More information about factoring may be obtained from another article of named Understanding Factoring is not brain surgery’ :

Forfaiting can be used by an exporter to sell (without recourse) to a forfaiter the bills of exchange or promissory notes (usually guaranteed by the importer’s bank). The bills are normally drawn payable at intervals (i.e. semi-annually) during the credit period agreed between the exporter and importer (i.e. one year or more) and are purchased at a discount by the forfaiter.

More information about forfeiting may be obtained from another article of named International Supply Chain Financing: Let’s go for Forfaiting’ :

Supplier finance or supply chain financing or reverse factoring, can be a solution for businesses that regularly supply a large company (buyer) with an appropriate contract in place. These businesses (suppliers) must have the following characteristics: large volumes, strategic importance and a long and steady relationship with the buyers. Unlike normal factoring where a supplier wants to finance his receivables, is a process started by the buyer in order to help his suppliers to finance more easily (and with better pricing terms) their receivables. Once the buyer has approved (validated) the invoice, the payment (less a fee) is made immediately (and ahead of terms) by the bank (or a factor). This allows the supplier to receive quick payment while allowing the buyer to repay the bank according to the original contract payment terms.

Mortgage loans can be provided by the banks using commercial real estate as collateral to secure loan repayment. Because it is such a long-term commitment, the terms of any mortgage agreement should be examined carefully.

Leasing or buying assets. When acquiring assets such as office equipment, company vehicles or machinery, a business will need to decide whether to lease or buy them.
Buying equipment outright may be advantageous in order to own the asset and be able to claim capital allowances to offset against its tax bill, and the overall cost should be less than through a leasing agreement. Some disadvantages of buying equipment outright are that paying the full cost upfront could affect cashflow while using a loan to fund the purchase will add to the cost. The business is also responsible for maintaining or replacing machinery, and the value of such machinery may depreciate over time.
Leasing can be better for equipment that outdates quickly, has high maintenance costs or is only used occasionally. It is also a way for a business to gain access to a higher standard of equipment which would be unaffordable if the business was buying outright. With leasing, it is also easier to budget in terms of monthly payments and to forecast cashflow as payments can be spread over a longer period of time to match income. One of the disadvantages of leasing can be that capital allowances on the leased assets cannot be claimed. It is also more expensive than buying the assets outright and the business could be locked into inflexible medium- or long-term agreements which may be difficult to terminate.
There are two main types of leases: finance leases and operating leases.
A finance lease is a long-term lease over the expected life of the equipment after which businesses can pay a nominal rent, sell or scrap the equipment. The leasing company recovers the full cost of the equipment (plus charges) over the period of the lease. The business is responsible for maintaining and insuring the leased asset.  
An operating lease, is a solution if a business will not need the equipment for its entire working life. The leasing company will take it back at the end of the lease and is responsible for maintenance.

Real Estate Leasing is an attractive alternative to financing commercial real estate through a mortgage. Leasing can be used to build new business premises (offices, logistics center, production facility, and warehouse) and save valuable liquidity, retain equity and optimize both ROE and budget. At the end of the contract term there is an option of purchasing the property at the pre-determined residual value or extend the leasing agree­ment or return the property to the lessor. Leasing companies finance 100% of the investment costs while the contract term is between 10 and 20 years. The amount of the lease payment depends on the financial standing of the business, the quality of the property, the pre-determined residual value, etc.

Sale-and-lease-back is another financing option. The leasing company purchases your real estate and leases it back to you immediately with a repayment period set in accordance with usage.

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