Written by: Abdula Ali Elabed
Financial statement lending places most of its emphasis on evaluating the information from the firm's financial statements (balance sheet and income statement). Financial statement lending information is often hard data and it’s a type of transaction-based lending.
The terms of the loan contract and decision to lend are principally based on the strength of the balance sheet and income statements. Financial statement lending is best suited for relatively transparent firms with certified audited financial statements. Thus, it is likely the technology of choice in bank lending to large firms. However, some small firms with long histories, relatively transparent businesses and strong audited financial statements also qualify for the financial statement lending.
Lenders rely on financial statements to obtain critical information about the financial health and risks of businesses. The average lenders don’t have ongoing inside access to the day-to-day operations of a company. Instead, they rely on the financial statements to provide accurate, readily comparable information, and observe the profitability and value of a business. A lender can review the financial statements to assess liquidity, cash flow, leverage and overall solvency.
Asset-based lending is a type of lending where the collateral is generally the account receivables and inventory. Asset-based lending information is often hard data and it’s a type of transaction-based lending. The credit decisions are principally based on the quality of the available collateral. This type of lending requires that the bank intensively to monitor the turnover of these assets. It is available to small firms of any size, but requires that the firm have high-quality inventory and receivables available to pledge as collateral.
When this type of lending is referred to as fixed-asset lending, the main data are estimated values of the real estate, motor vehicles, or equipment leased or pledged as a collateral. Fixed asset lending is quite cheap for the bank since it doesn’t involve any continuous monitoring activity and only requires an evaluation of the pledge assets when the loan is provided. Hence that it is very monitoring-intensive and relatively expensive for the bank.
The most important benefit that the company gets from using asset-based financing is improved liquidity. The facility can provide financial stability and predictable cash flow when it used correctly. This can help to stabilize operations for companies that are growing rapidly, have seasonal revenues, or have tight cash flows. Also, it is easier to get than loans and lines of credit, more flexible than other types of financing, and it can be obtained quickly (The application and underwriting process is much faster than qualifying for a conventional loan or line of credit).
In addition, it has fewer covenants than conventional lines of credit, can be used as a stepping-stone to other products, and have lower costs than comparable solutions, such as factoring. On the other hand, it’s have costs. In the asset-based lending, the lender gets to seize the assets in the event of failure of repayment, and the high rate of interest on the assets which lead to the limit of lending to be lower in this approach. Also, it requires a lot of monitoring and auditing, and it has many appraisal costs and the up-front legal costs of this system are high.