Asset Financing - An overview

Asset financing in a nutshell.

Summary: Asset financing is simply raising capital (equity and debt) by an organisation to acquire an asset, leveraging it and reducing the need for full upfront cash outlay or impacting other credit lines. In the case of corporate banking, this typically involves debt arranged by lenders. Such assets include ships, data centers, real estate, and machinery.

Financing the purchase of assets can come in various ways:

1) Full cash outlay:

a) Company uses existing cash or equity to buy the asset and gains full ownership of the asset.

b) No debt incurred, hence no implication on gearing (debt-to-equity). 

c) Ties up liquidity which could be used for other purposes (opportunity cost).

2) Debt financing: 

a) Company borrows money from banks to finance the purchase of the asset. 

The asset serves as the collateral of the loan. However, due to loan limits (i.e. LTV), they will still need to inject cash/equity to finance a portion of it (e.g. 20% of the asset price). The company gains full ownership of the asset from the start.

b) The company makes regular payments (P+I) to the lenders.

c) Preserves cash but adds debt to the balance sheet.

3) Leasing:

a) In the case of corporate banking, the bank could purchase the asset and lease it to the company with regular payments for the right to use the asset over a period of time. The ownership thus sits with the bank.

b) At the end of the period, (1) the lease could be extended; (2) the company may choose to end the lease, and the bank will then dispose the asset; (3) the company may purchase the asset from the bank entirely.

c) Preserves cash and gives the company flexibility.

Which method of financing is right for the company? This depends on the company's financial health, cash flow / balance, business opportunities / needs for cash etc.