Cash Flow-Based Lending Versus Asset-Based Lending
Lending based on Cash flow places the source(s) of cash flow at the centre and the facility structure is built around it. Cash flow source(s) and Facility Structure are of prime importance for such lending.
Asset-based lending is largely balance sheet-driven lending and is not tied to a specific cash flow. Company’s financial strength and secured assets offered for the facility are the two pillars to drive such lending.
The cash flow-based lending could be based on specific cash flow from (i) Project being developed by the company (ii) Service contract executed by the company (iii) Receivables from committed sales as per sales agreement (iv) any other contract that commits generation of cash flow for the company. The repayment of the lending is from the specific cash flow.
Asset based lending is wholistic in its assessment and considers the financial strength of the company; it gets repaid from any of the liquidity sources available to the company. The secured asset in such lending could be (i) Real Estate assets (ii) Equipment/ machinery (iii) shares (iv)deposits & structured products, etc. The amount that the lenders are prepared to advance is calculated by reference to certain asset classes - typically plant and machinery, real estate property, shares, etc.
The source of cash flow is important in cash flow-based lending, which is usually a third party. Lenders, Analysts, and other parties assess the (i) ownership of the source (ii) financial strength of the source (iii) period for which the cash flow will be available (iv) value of the cash flow (v) credit history of the source.
In Asset-based lending, Lenders, Analyst, assess the (i) credit history of company (ii) its past financial performance (iii) business plan (iv) industry position & competition analysis. As secured asset is one of the main drivers for such lending, Lenders assess (i) ownership of the security (ii) third party valuation of security (iii) marketability of the security (iv) enforcement regulations.
The above points are also evaluated for cash flow-based lending; however, the prime focus is on the specific cash flow.
Cash flow-based lending could be considered by lenders even if the borrower is passing through a rough patch in its financial performance; lenders get comforted by the specific identified cash flow that would repay their commitment. However, during a rough patch the probability of Asset-based lending is low.
If we consider cash flow based lending and Asset based lending as the two ends of a spectrum; significant lending happens in the mid of the spectrum with nuances of both cash flow based lending and Asset based lending.