Asset financing refers to the use of a company’s balance sheet assets, including short-term investments, inventory, and accounts receivable, to borrow money or get a loan. The company borrowing the funds must provide the lender with a security interest in the assets.
Here, I do not intend to make an accounting presentation, but before explaining what solutions you have to finance investments in your company, it seems important to define what we are talking about.
Definition of a fixed asset
A fixed asset is a tangible or intangible asset that remains in the company. It is not subject to the short-term economic cycle. It has a shelf life of several years. As it remains in the company, it is also often called immobilized.
An investment usually refers to the fact of buying a fixed asset. Although, sometimes, due to a bad use of language, the term investment is used for expenses and purchases.
For example, you hear phrases like “ we have invested a lot in advertising this year ”. Advertising, with few exceptions, is an expense. If you pay for online or television advertising, the service is consumed at the moment.
However, if the money is used to install a billboard that will stay on the roof of the company for years, it would be an investment in a fixed asset.
Examples of fixed assets
The tangible fixed assets include physical assets that serve the functioning of the company. Installation works, furniture, computer equipment, vehicles, machinery, or tools are some of the most common examples of property, plant, and equipment.
The intangible assets include various assets such as computer developments, bonds, shares in companies, and other intangible.
Accounting treatment of fixed assets
In accounting, fixed assets are assets that are recorded as such on the company’s balance sheet.
To reflect their loss in value, each year they are depreciated within values included in tables established by the Treasury. The idea is that each asset is depreciated based on its theoretical useful life. In this way, the expense reflected in the income statement is distributed over the different years in which we will use the asset.
Most assets depreciate, but some remain. For example, it would not make sense to depreciate a surety, since its value remains the same over time.
Difference between financing investments and financing working capital
With those little explanations, I think it is very well understood that financing investment is something very different from financing the normal course of the company.
When you buy a fixed asset, you have to pay a significant amount at the time, for a good that will generate income over several years (its useful life).
Seen this way, it is perfectly understood that the financing solution is also considered in the long term, with credits and loans of several years. Financing an investment with solutions designed for working capital (such as a line of credit) would be a serious mistake from a financial point of view. It would cause a significant imbalance in the finances of the company.
A fixed asset is a long-term asset, and as such, logically, it has to be financed by long-term liabilities.
How to finance fixed assets: 5 options
Excess cash of the company
If the company has generated in previous years a large amount of cash that is not needed for the day-to-day operation of the business, then those funds can be used for investment.
I am not going to elaborate further on the subject. I think that any businessman who has enough cash to finance all its investments will not be very interested in reading an article on how to finance fixed assets. Am I wrong?
A capital increase
Another interesting strategy is to ask shareholders to finance the investments of the company. Specifically, a capital increase is made, which results in an increase in the company’s treasury, and the money is used to buy the necessary fixed assets.
In theory this is fine, but many times shareholders are not willing to put more money into the company and prefer to opt for bank debt financing. After all, their liability is limited to the capital invested, and they prefer not to have to increase it unless it is very profitable.
A classic credit
Anyone who has had to apply for a mortgage knows how a classic loan works. The bank provides an amount, which you have to pay back little by little, month by month, in exchange for an interest rate.
Although it is a very common type of financing in the case of individuals, companies do not use it as often, and one of the reasons is VAT financing.
I explain. Let’s say I need to invest $500,000 in an investment project. If the project is done by me and I finance it with a classic loan, in the short term I will need to disburse $605,000, counting the $ 105,000 VAT of the assets purchased.
Now, as a company, I can offset the VAT with the amounts that I will receive for that tax. But it may take a long time to do so. Worse, it is possible that my activity generates little VAT. It would be the case if I export a lot, for example.
In any case, I am forced to finance an additional $105,000. If I do it through credit, it costs me more in interest. If I do it any other way, I damage my treasury for a long time.
Finance fixed assets with a lease (or a leaseback)
Leasing is nothing more than a rent-to-own. Instead of lending me the money so that I bought the property, the bank or finance company rents it to me. Therefore, I do not have to pay anything, I am only obliged to pay the monthly installments for the duration of the contract. At the end of it, I have a purchase option for the asset. You are not obliged to exercise it.
Consequently, it is no longer necessary to advance the VAT at once. It is a much more comfortable type of financing for the renter, and it is no surprise that many companies choose to lease.
One of the limitations is that leasing is associated with a specific physical asset. If your investment consists of buying the development of a web page, you will hardly be able to get a lease. But it is a very common choice for machinery, vehicles, computer equipment, or real estate.
The leaseback is a lease, but instead of buying a new well, you give one that you owned to the financial institution, which in turn rents it to you with the option to buy it again at the end.
The renting (and rent back)
Renting is another type of financial rental. The difference with leasing is that there is no option to purchase the property at the end of the contract. Like leasing, it allows you to avoid advancing VAT on investments.
It has the same limitation regarding the type of assets that can benefit from the financing of fixed assets by renting.
The rent back is the possibility of assigning one of your immobilized assets to the financial institution so that it can be rented back to you. It is not the most popular option to finance fixed assets, but it is interesting.
Prepare a business plan to analyze the need for financing your investments
The best way to determine the ideal financing mode for your fixed assets is through an analysis of your investment.
In particular, it is important that you analyze your return on investment, establishing a realistic schedule of income generated. The future cash flows are what will have to allow you not only to cover your operating payments, but also the interest and the repayment of the loan principal. Therefore, it is important to have a good profitability study of the project, reflected in a business plan like the ones I prepare in my consulting activity.
If you’re considering taking any type of loan in asset financing, we, at Fincue, can help you out. We will get you an appropriate broker that will get you the lender suitable for your business with the best terms and conditions. You can speak with us today.