Question

1. Asset-based lending provides advantages and disadvantages when compared with cash flow lending.

Identify and describe these advantages/disadvantages and provide examples where necessary.

Answer 1

Solution

1. Asset Based Lending means entities borrowing money based on pre-determined values of Company Assets. Usually these would be secured against the Accounts Receivable, Inventory and also includes Land, Property, Plant & Machinery etc.,

Advantages of Asset Based Lending;

(a). Usually the qualification criteria & the credit guidelines for Asset Based Loans are simple, quick and easy to comply.

(b). Using this lending mechanism the entity can easily monetize the locked out working capital.

(c). In some exceptional cases where an entities Credit rating is not so good based on the quality of current assets funding for the organisation may be obtained quickly.

(d). In the case of fast growing organisations having huge funding appetite this method of lending would be of great help as normal Bank Lending process is very time consuming & process wise too cumbersome.

Disadvantages of Asset Based Lending;

(a). The Lender seeks to maintain high level of Monitoring & high level of Audit Control.

(b). Since this type of Lending involves high risk (as the loans are secured against Current Assets) the Interest rate will also be very high.

(c). In the unfortunate situation of the Entity (borrowed) failing to meet the Interest or Repayment conditions then the Borrowed will automatically get a lien over the Currents Assets provided as a Collateral.

(d). Despite ABL is easy & quick to comply it involves high appraisal cost & very high upfront legal costs (to secure legally the Current Assets in favour of the Lender).

2. Cash Flow Lending means entities borrowing money based on guaranteed borrower's business Future Cash Flows. In other words loans are taken against future profit earning potential.

Advantages of Cash Flow Lending;

(a). Cash Flow lending is very easy when the entities Credit health is very good - more importantly established entities can secure this type of borrowing easily.

(b). When the future cash flow projections are reasonably assured and if the business has a history of meeting its Targets consistently then this method of borrowing is easy

(c). For established & good credit rated entities this type of lending can be converted into a Structured Revolving Credit which can lead to a constant source of funding.

Disadvantages of Cash Flow Lending;

(a). Cash Flow Lending are not easy for new Start up or those entities with not so good credit score.

(b). If the business model or the business environment is not good then lenders may not be ready to extend lending under this option as they entail high risk on loans.

(c). This type of Lending invariably requires an Underwriting which may be expensive based on the Loan amount, Tenure of repayment etc.,