What is “Asset Based Lending”?
Asset-based lending (ABL) is borrowing which is achieved by using business assets as collateral. The types of assets used as collateral for asset-based lending include accounts receivables, inventory, and PP& E. Asset-based lending is used for several purposes, including:
- Meeting the working working capital needs of growing companies whose funding needs exceed their cash inflows from earnings or equity
- Seasonal businesses requiring a build-up of inventory to meet seasonal demand
- Businesses looking to restructure their existing financing arrangements
- Long-term funding needs such as mergers and acquisitions
The interest rate for asset-based lending depends on the lender’s confidence in the borrower’s collateral. The interest rates will be higher for collateral that is considered to be riskier by the lender.
Key Learning Points
- Asset-based lending (or asset-based finance) is a loan secured using a business’s assets as collateral
- Accounts receivables, inventory, and PP&E are commonly used as collateral
- Asset-based lending is used for both short-term and long-term financing needs
- The amount of loan provided by the lender varies by the type of asset used as a collateral
- The loan to value (LTV) ratio expresses the relationship between the loan amount and the value of the asset
- Accounts receivables provide the highest loan to value ratio
- Inventory carries a low loan to value ratio due to uncertainties about its eventual sale.
- Some lenders may exclude work-in-progress inventory for LTV calculations
- For property and plant and machinery, lenders may rely on the value stated in the company’s financial statements or perform an independent assessment to determine their value
Types of Assets Used for Asset Based Lending
Asset-based lending helps businesses use their assets to meet their funding needs. The amount of financing can vary by the asset type used as collateral.
Accounts receivables are a key component of asset-based lending. Depending on the borrower’s total assets, funding received using receivables as collateral can be 60% or more of the total funding amount. Borrowers will typically present invoices to lenders at an agreed-upon frequency, and lenders release funds at an agreed interest rate. Depending on the lender, borrowers can get 85% to 95% of the total eligible receivables as loan.
Inventory or stock is a riskier asset to use as collateral as compared to receivables. While receivables represent sales already made, there remains uncertainty around finding buyers for existing inventory. The lender will independently assess the inventory’s value based on its reported value in the balance sheet or through third-party verification. Typically, lenders will distinguish between finished goods and work-in-progress (WIP) or partially completed inventory. While finished goods are generally accepted as collateral, not all lenders may accept WIP.
Plant and Machinery
When plant and machinery are used as collateral for asset-based lending, its value could be based on its book value or determined independently (or a combination of both). Such a valuation is done at the beginning of the loan period and during the loan’s life. Borrowers can get a loan of usually up to 75% of the asset’s value.
The valuation of property for asset-based lending can depend on the property’s market value or an independent assessment done by the lender. The amount of loan can usually be up to 70% of the property’s value.
Example: Asset Based Lending
Suppose a business is looking at $50,000 for its short-term financing needs. It can opt for traditional bank lending, which will rely on the company’s future cash flows to determine its loan eligibility amount. Alternatively, the business can opt for an asset-based loan.
We have been asked to calculate the amount of loan the business is eligible for based on the value of its collateral.
The table above includes the assets of the business and their respective value. The loan to value ratio expresses the ratio of the loan to be provided by the lender based on the value of an asset. Here, we can see the loan to value ratio varies based on the perceived ‘riskiness’ of the asset. Accounts receivables are deemed to have the lowest risk and thus offer a high loan-to-value ratio. Inventories are riskier and therefore offer a lower loan to value ratio.
The loan amount is calculated by multiplying the value of the asset and the loan to value ratio. Based on the value of the assets and the respective loan-to-value ratios, the business can get a loan of up to $56,000.
Example 2: Different types of Collateral
Identify whether the following statements regarding different types of collateral used for asset-based lending are true or false