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Also known as asset-based financing, asset-based lending is referred to the business of providing money through a loan in an agreement that is guarded by Collateral.
An asset-based line of credit or loan could be secured by equipment, accounts receivable, inventory or any other property that the borrower owns.
Several businesses have to take loans or avail lines of credit to fulfil routine demands of cash flow. For instance, a firm may get a line of credit to ensure payroll expenditure is covered, despite a slight delay in payments that the company anticipates receiving.
In case a firm is seeking loan but is unable to showcase the adequate amount of cash assets or cash flow to cover the loan, the lender may offer to show physical assets in the form of collateral so as to approve the loan.
Let’s take the example of a newly created cafeteria. The café may get a loan only by keeping its equipment as collateral as it doesn’t still have enough cash flow. Generally, for an asset-based loan, terms and conditions depend upon the value as well as the type of assets that are being put forth in the form of security.
Often, lenders prioritize those who can keep highly liquid collateral, such as securities or Bonds that can be converted into cash instantly if the borrower defaults the payments. Loans that are obtained with physical assets are regarded riskier; thus, the maximum loan will be lesser than the actual value of the asset.
Furthermore, interest rates also vary to a great extent, depending upon the credit history, time spent operating the business and the cash flow of the applicant.
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Here is an asset-based lending example to consider. Suppose a company is seeking Rs. 20,00,000 worth of loan to expand its functions and operations. In case the firm has pledged its highly liquid marketable securities as collateral, the lender may provide an 85% of the loan as per the value of the collateral securities.
Suppose that the securities are valued at Rs. 20,00,000. In this case, the lender will only offer Rs. 17,00,000. On the other hand, if the company chooses to keep less liquid assets, like equipment or Real Estate, the lender will offer 50% in the loan, which will be up to Rs. 10,00,000.