What Is a Floating Charge?
Let me explain what a floating charge is. It's a security interest or lien over a group of assets that aren't fixed—they change in quantity and value over time.
You see, companies use floating charges to secure loans. Usually, loans are backed by fixed assets like property or equipment, but with a floating charge, it's typically current or short-term assets that fluctuate in value.
Key Takeaways
- A floating charge is a security interest or lien over a group of non-constant assets that change in quantity and value.
- A floating charge is used as a means to secure a loan for a company.
- The assets used in a floating charge are usually short-term current assets that the company consumes within one year.
Understanding a Floating Charge
Floating charges let business owners access capital backed by dynamic or circulating assets. These are short-term current assets, typically used up by the company within a year. The charge secures these assets but still allows the company to use them in daily operations.
Current assets include things the firm can quickly turn into cash, such as accounts receivable, inventory, and marketable securities. For instance, if inventory secures a loan, the company can still sell it, restock, and alter its value and quantity. That's why it's called 'floating'—the value and amount change over time.
Important Note
A floating charge is useful for companies because it lets them finance operations using current assets like inventory.
Crystallization of Floating to Fixed Charges
Crystallization is when a floating charge turns into a fixed charge. If a company can't repay the loan or goes into liquidation, the floating charge crystallizes or freezes into a fixed one. At that point, the assets are fixed, and the company can't use or sell them—the lender can take possession.
This can also occur if the company stops operations, or if the borrower and lender end up in court with a receiver appointed. Once crystallized, the security can't be sold, and the lender may seize it.
Fixed charges are usually on tangible assets like buildings or equipment. For example, a mortgage on a building is a fixed charge, and the business can't sell or transfer the building until the loan is repaid or conditions are met.
Floating Charge Example
Take Macy's Inc., one of the largest U.S. department stores. Suppose the company takes a loan from a bank using its inventory as collateral. The lender holds a floating charge on that inventory, as per the loan terms.
Looking at Macy's balance sheet for the quarter ending November 3, 2018, inventories were valued at $7.147 billion. In the prior quarter ending February 3, it was $5.178 billion. You can see how inventory values fluctuate each period due to changes in quantities and values. This is why the assets can 'float' in price and quantity while securing the loan.
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