Last editedJun 20212 min read
If at any point you need to borrow money for your business, the creditor will usually take some security for that debt. Why? To protect their position and to recover the money owed if you fall into insolvency, which means you are unable to pay the debt. These types of security are known as fixed and floating charges.
Let’s start with fixed charges. A fixed charge is a form of security that is attached to an identifiable business asset, such as property, machinery, or copyright. These assets are not usually sold and the fixed charge is applied to protect the repayment of the debt.
With fixed charges, the lender has full control of the asset, so if you – the borrower – should want to sell that particular asset in the future, you must have permission or settle the debt beforehand. In the unlikely case that your company falls into liquidation, holders of fixed charges will take precedence over other creditors and would be entitled to be repaid first. When a lender has a fixed charge, it has the power to appoint a fixed charge receiver to take control of the asset and re-sell it to repay the debt.
Fixed charges examples
Examples of fixed charges include:
Bill of sale (a document that transfers ownership of goods from one person, or company, to another)
Goodwill payment in administration
Factored book debts (factoring is a method of financing whereby a firm sells its trade debts at a discount to a bank or financial institution)
Fixed charges vs. floating charges
It’s important to understand the distinction between fixed and floating charges. So, if a fixed charge is applied to a specific asset, what is a floating charge? As its name suggests, a floating charge is dynamic, as opposed to being fixed or settled. It refers to the interest applied to a company’s non-constant assets, which may change in value and quantity. Examples of floating charges include stock, inventory, accounts receivable and machinery.
While an asset covered by a fixed charge cannot be sold without the lender’s approval, a floating charge can be sold, transferred or disposed of until it crystallises. Upon crystallisation, the floating charge attaches to all existing assets that are within the scope of the charge and it becomes a fixed charge. In company insolvency, a fixed charge repayment ranks before that of a floating charge.
What is a debenture in relation to fixed and floating charges?
A debenture is a written loan agreement between a borrower and a lender that is registered at Companies House. The document sets out the terms of a loan and the types of charges involved – fixed or floating. It details the amount borrowed, interest, when the debt needs to be repaid, charges securing the loan and insurance, plus more. Debentures give the lender security over a borrower’s assets.
The fixed charge coverage ratio
The fixed charge coverage ratio determines a company’s ability to cover its fixed charges. Financial institutions such as banks will often look at this ratio when evaluating whether to lend money to a business.
To make the calculation, you need the earnings before interest and taxes (EBIT), fixed charges before tax (FCBT) and interest expense (i).
The formula for the fixed charge coverage ratio is:
FCCR = EBIT + FCBT / FCBT + i
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