Member Article

Pros and cons of asset based finance

Following on from an article last week on private funding, this week Stuart Stones, partner at Ratio Law LLP, discusses the potential pros and cons associated with asset based finance as a form of business lending.

Sometimes seen as a lender of last resort, and with occasional bad press, asset based finance can nevertheless offer an alternative source of finance for SME businesses. The most common arrangements are factoring, invoice discounting and asset based lending.

Factoring

This service allows businesses to draw immediately against issued invoices. The factoring company generally pays 80 ? 85% of the face value of each invoice and takes all necessary steps to recover the balance. On receipt of the monies, it then typically deducts any pre-approved charges, with the balance paid over to the business. A full factoring service essentially amounts to a fully outsourced credit management and collection administration, which may deliver time and cost savings to the business.

Although factoring can provide a convenient and predictable source of cash, it is not the cheapest method for accessing funds; although some arrangements may provide protection from exposure to bad debts. Factoring collection and/or bad debt protection charges are usually expressed as a percentage of turnover and are commonly fixed at between 0.75% - 2.5% depending upon workload and the likelihood of recoverability as assessed by the factoring company.

Invoice Discounting

Invoice discounting is slightly different to factoring in that the business retains responsibility for credit control. However, the mechanics are similar. As and when the business issues invoices, the invoice discounting company makes an immediate payment, again typically 80 ? 85% of the monies due. Customer payments are transferred into a bank account administered by the invoice discounting company, and then paid to the business, less charges. These charges usually take the form of a flat fee or percentage of the business’ turnover. On top of that fee, invoice discounters also typically charge interest on the monies paid up front, usually at rates comparable to standard secured overdraft rates. As with factoring, invoice discounting can help businesses to maintain a steady cash-flow in the short-term.

Factoring and invoice discounting can be particularly helpful for businesses that require cash in the bank to buy stock, pay suppliers or meet high rental or mortgage payments.

As a temporary source of cash, or short-term arrangement, both services can be very helpful. However, if longer term support is required, owner-managers may find traditional bank lending, or private funding, to be more cost-effective.

Asset based lending

Asset based lending allows organisations to use their assets as security. Asset based lenders will typically agree to lend against either tangible and intangible assets owned by the business, or even a combination of the two ? for example property, plant, stock, books of work or even a brand name.

Asset based lending is often used by businesses with seasonal sales cycles, or to fund capital purchases. Again, it can also help to ease cash flow difficulties.

A final word?

In essence, asset based finance products tend to be most appropriate for businesses that require quick access to cash. The products tend to be easy to access, and provide instant relief. On the flip side, convenience costs, and these products may have higher than expected interest rates and fees.

Owner-managers should always consider every option when it comes to accessing finance, and should always speak to a wide variety of different potential lenders.

Please see other articles by Stuart here.

This was posted in Bdaily's Members' News section by Ratio Law LLP .