What does fixed charges and floating charges mean? what are the advantages ad disadvantages of fixed and floating charges? This article will explain all you need to know about fixed and floating charges.
Fixed charges are more stable and predictable, since the rate is known in advance. They can be more difficult to manage, since the company must predict its expenses in order to calculate a fixed charge.
If they over- or under-estimate their costs, they may not be able to recover that money through increased revenues. Fixed charges also require companies to make hard decisions about when an expense is worth including in the fixed charge or when it is better off as a variable cost, which can lead them to adjust their rates on a frequent basis.
Floating charges are less stable and less predictable because they are calculated at least monthly (and sometimes weekly) based on actual revenues and expenses incurred by the company during that period of time.
Different types of contracts between parties might call for different terms and conditions. Fixed charges are those that remain the same over the life of an arrangement while floating charges change based on market conditions.
Floating charges are generally preferred because they allow users to lower their energy costs in good economic times and raise them during bad ones without fear of being penalized by a fixed-rate contract.
This article discusses both fixed and floating rates in detail, as well as summarizing the benefits offered by each type of contract model.
What Are The Meaning Of Fixed And Floating Charges?
Fixed charges are one of the two types of fixed-rate contracts available. In this type of contract, both parties agree on a specific fixed charge, and agree that the rate will remain the same until it expires.
Fixed charges do not change over time. The period over which the charge remains fixed is also known as the ‘period’. Fixed charges are defined in terms of calendar days (a day for every day that the agreement is valid).
Fixed charges are over substantial and physical assets. For example, if one party agrees to continue paying for a fixed charge for 20 years, that charge will still be valid for at least the 20-year period. Fixed charges are over immovable assets like buildings or machinery.
Fixed charges are also over intangible assets like patents, trademarks or copyrights. This is because although these expenses may not be visible to the outside world, they still impact the performance of the business and needs to be paid out in some way.
Some fixed charges are over an identifiable market segment like a certain type of product or service. Fixed charges could also be used over an intangible investment like shares in a company. In this case, a holder of the shares would maintain ownership but not possession of the fixed charge.
The main advantage of a fixed charge over other types of contracts is that it is easier to manage. The party or business receiving the fixed charge knows in advance how much they need to pay and when they will have to pay it.
They can budget their expenses accordingly and avoid potential financial risks associated with variability in charges. Confirming the fixed amount paid each time based on its own activity is also easy.
A floating charge is a type of security that a creditor undertakes on an entire business’s assets in respect of a particular debt. A floating charge allows a business to borrow even when it does not own a particular asset like premises, which can act as a security.
This allows the business to take out a loan and use the money for renovations, capital investments or marketing campaigns. The main advantage of a floating charge is its adaptability.
The creditor knows the asset they are lending against may change over time, but they know the security will always be enough to cover their loan if the borrower fails to pay. The creditor also knows any legal proceedings will not affect their claim over the floating charge first, regardless of what happens to other assets owned by the borrower.
However, this kind of security does not charge fees for managing it and does not offer any interest payments on top of principal repayments. This means that while the floating charge can be highly adaptable, it is not as reliable as fixed-rate contracts.
What Are The Basics Of These Two Charges
Fixed charges are fixed, which means they will remain the same over time. Fixed charges are also known as periodic or recurring charges. In a fixed charge, both parties agree on how much money each party will pay and how often that amount will be paid.
The case of two parties agreeing to pay an amount of money each month is known as a periodic agreement. The payment due on an agreement is valid for the period duration and hence it is also called periodic payment or recurrent payment.
The case of two parties agreeing to pay an amount of money each month, but that amount is not constant and depends on market conditions and the performance of the business is known as a floating charge.
It is a like a flexible, adjustable loan where payments are made according to the financial performance of the business or indirectly by reference to market conditions. Floating charges are defined in terms of calendar days (a day for every day that the agreement is valid).
Floating charges are not over specific fixed assets like buildings or machinery. The main advantage of floating charges over other types of contracts is its adaptability.
Moving on to the next topic, let’s discuss about the advantages and disadvantages of fixed and floating charges.
Advantages And Disadvantages Of Fixed and Floating Charges
Here we will be discussing about the advantages and disadvantages of fixed and floating charges but firstly, we will look into the advantages and disadvantages of fixed charges and then later to the advantages and disadvantages of floating charges.
Advantages Of Fixed Charges
- An advantage of fixed charges is that they help to make sure everything is covered and the business is protected. When fixed charges are in place, it means that the business has enough money in good times and bad to deal with unexpected events.
- Fixed charges also help by smoothing out spikes in income or expenditure. Fixed payments over time mean that things will run smoothly and your business will not be affected by sudden fluctuations in income or expenditure like a spike in demand, new product introduction or another business event with high costs.
- Fixed charges also help manage your cash flow, which means you never have too much cash at any one time.
- Another reason why fixed charges are so important is that if the company does undergo an insolvency event then the holder of the charge is first in line to be repaid above other charge holders.
One common disadvantage of a fixed charge is that it will only cover your business until certain point in time. Once that fixed period has come to an end then the holder of the charge will have no further obligation to you for any amount past the expiry date.
Fixed charges are also difficult to administer because they are dependent on how often your business makes payments and so must be updated accordingly in order to be valid. This can create challenges if your business is on a tight schedule or if it requires a lot of adjustments.
Advantages Of Floating Charges
- Even when the company does not have any fixed assets, a floating charge can be created.
- It offers a lot of freedom to business owners.
- The business is free to deal with the asset as if it was never secured. A business does not need any permission or consent from the lender before buying or selling the asset.
- The holder of the floating charge is not bound by any expiry date.
- In case of liquidation of the company, the floating charge holder can appoint an administrative receiver who will ensure maximum return to them.
One disadvantage of floating charges is that the holder does not have a specific claim on any specific asset. This means that if the company fails, the holder may need to prove which assets were used in order to get the money back.
The other disadvantage would be that if business owners want to change things in future and make it more valuable then they cannot use this floating charge anymore.
So, keeping these advantages and disadvantages in mind, you should take a decision for your businesses as by using fixed or floating charges for your business can bring different results for different cases.
After looking at the advantages and disadvantages of fixed and floating charges, we are confident that you have understood the differences between them.
As you can see, a fixed charge covers your business for a specified period of time. If it is over that period, then the holder will have nothing to claim against you.
However, if it is not or if there are other claims by other people who are owed money by you, then those other claims will be higher in priority than the holder of a fixed charge.
A floating charge, however, can be set over any or all of the company’s assets and it will cover those assets for an indefinite period of time. This is because there is no specified expiry date and so the company can continue to use the asset as its use changes over time.
Furthermore, one beneficial advantage of a floating charge is that you can create it without having to pay any money up front.