Working capital is the backbone of any business operation. At some point, businesses may run low on working capital, resulting in dysfunctions. In such instances, business turn to taking loans: either asset-based loans or commercial and industrial loans. These two serve the same purpose of sustaining a business’s operations. However, they differ in several ways. The main difference between them is that in ABL, the collateral is a business asset, while in C&I, it can be any usual collateral. ABL is commonly considered more expensive that other methods, and here’s why.
Cash flow loans have yet to learn of collateral and rely solely on the business’s potential to create future income. Therefore, their credit rating influences whether they are applicable for cash flow loans. Alternatively, asset-based loans look at the company’s current assets and what might be good for collateral. In the event of a loan failure, the lender can use such collateral assets in the future. The assets reviewed by an asset-based lender will vary slightly, but lenders all look at the same general forms of collateral. For this reason, asset-based loans seem more expensive than C&I loans.
- Asset value and performance ratios
Commercial loans are generally based on financial measures influenced by company profit and loss. Asset-based lending focuses on the worth of a firm’s assets to determine lending availability. As a result, ABL is more concerned with asset value and less concerned with performance ratios.
Accounts receivable, inventory, machinery and equipment, and real estate are all firm assets that can be good as collateral. Asset-based lines of credit depend on the value of all eligible assets as a “borrowing base” and an advance rate that changes depending on the type of collateral.
- Greater Risks
Businesses generally employ ABL loans with a poor credit history or that operate in a volatile industry. This makes them a higher risk for the lender. As a result, to compensate for the increased risk, lenders may charge higher interest rates.
- Suitability factor
Since every firm is unique, you must adapt loan conditions to meet the various criteria and needs. Asset-based loans are not ideal for all enterprises much like how cash-flow-based loans aren’t ideal for all enterprises. The company’s credit rating is important in determining how much or if a corporation can borrow in the first place in a cash-flow-based loan. These loans are best suited for companies with excellent credit and a considerable volume of recorded cash flow. Asset-based loans are better suited for borrowers with low cash flow or poor credit ratings. In addition, the assets must be valuable enough for the bank or other lender to take a chance on the loan.
- Continuous monitoring
ABL loans frequently necessitate constant lender monitoring. This is to ensure that the borrower is maintaining their financial obligations. They also ensure that the value of the assets used as collateral is not decreasing. This additional monitoring may raise the loan’s interest rate.
- Flexibility and ease of obtaining a loan
Banks usually have stricter lending limits, liquidity, repayment schedules, and other unique covenants. As a result, they have less room to be forgiving of:
- high-risk businesses
- performance problems
- unusual consumer concentrations
Speciality ABL lenders have extensive knowledge and resources to estimate asset valuations and can finance a wide range of unusual scenarios. A lender with industry experience may also give better advance rates on your specialist assets. They may also include collateral such as unbilled accounts receivable, which typical lenders do not accept.
On the other hand, traditional term loans and lines of credit are often secured by the borrower’s creditworthiness and do not require continuous monitoring. As a result, the cost structure of these loans may be lower for the borrower. Therefore, selecting a lender who knows your company’s situation and is ready to provide the care it needs to advance is critical.