What Is Cash Flow Lending and How Does it Help Businesses?
Businesses that seek more working capital or project funds can get a loan using their future cash flow as collateral. This is called cash flow lending, a secured type of financing that is relatively common among small and big businesses.
While cash flow lending helps all companies, it is especially beneficial for small businesses and startups that do not qualify for standard business loans. These enterprises have promising revenues but lack established records of profitability and inadequate assets to be pledged as collateral.
Unlike traditional business loans that are often in substantial amounts and repaid monthly, cash flow loans are small and often paid in small daily increments. The interest rates and terms vary greatly between loan providers.
Cash Flow Lending Vs Asset-Based Lending Vs Invoice Lending
Businesses can pledge different holdings to secure a loan, including cash flows, physical assets and invoices.
Cash Flow Lending
Cash flow loans are typically short-term, which means that the repayment needs to be completed only within six months to a year and a half. The loanable amount is also smaller compared to other types of business loans but enough to cover a temporary financial shortfall that needs to be addressed immediately. These include scheduled salary payment for employees, purchasing equipment that’s on sale for a limited period of time and buying more input materials to meet a large supply order for a product.
While businesses that need a cash flow loan are temporarily underfunded, they are expecting revenues to come in soon. The lender uses the projected cash flows as bases for granting or denying the requested funds and, if approved, for the interest rate and terms of the loan.
This projected cash flow is determined using computer algorithms that factored in various business data, including:
- Transaction volume and frequency
- Seasonal sales
- Profits from returning customers
- Customer reviews
This form of financing uses the business’s assets as security for the loan. Although the company’s cash flow is also an asset, the lender puts more value on the business’s liquidated value from physical properties and inventories.
Physical assets can be real estate properties, equipment and vehicles. Company inventories include raw materials and finished goods and merchandise.
If the business fails to repay or defaults on the loan, the lender will seize the assets and sell them to recover the defaulted loan values.
Invoice financing allows businesses to borrow money against their outstanding invoices from clients. Unlike other business loan types, there are no interest payments or asset requirements. The loanable amount is only limited to the size of the unpaid invoices that were pledged as collateral.
This type of financing helps businesses improve their working capital and cash flow, pay for business expenses and speed up expansion and investment plans earlier than they could if they had to wait for their clients’ payments.
Invoice financing can be:
- Invoice Factoring. The business selects specific invoices to send to the lender. In turn, the lender provides advance funds for the individual invoices. Any adjustments to the funds received are made daily.
- Invoice Discounting. The lender gets access to the company’s full invoice ledger and collects all the clients' debts when they’re due. They will receive a certain percentage of the invoice every time a customer pays, usually 80-90%, while the remaining invoice value will be transferred to the business.
Invoice financing helps businesses improve cash flow, pay employees and suppliers, and reinvest in operations and growth earlier than they could if they had to wait until their customers paid their balances in full.
This financing plan can also be structured in a way that the company’s clients do not have the slightest idea their invoice has been financed or explicitly managed by the lender.
When Does Cash Flow Lending Work Best?
Cash flow financing is easier to get than other business loans because it is based on business-revenue generation. But is it an ideal loan option for your business?
Emergency Working Capital Expenses
A cash flow loan helps temporarily underfunded companies pay for expenses that are necessary to maintain its smooth business operation, like payroll and utilities, without touching its savings. An example of this is a startup retail company that still awaits the payment of one of its largest clients but has to release the monthly salary of its employees in 10 days.
Provision of New Equipment
If a startup or a small business doesn’t make large profits yet but can dramatically increase its production and profit by buying new equipment or machinery, cash flow financing can help get the necessary funds. Unlike in equipment financing, the new equipment or machinery doesn’t need to be pledged as collateral for the loan.
A business that wants to act on an opportunity that’s too good to miss can seek a cash flow loan to get the funds fast. Unlike a standard business loan, cash flow lending is easier to apply for and get approved. This works best in business opportunities that need to be acted upon quickly, like supplying the bulk order of raw materials to a manufacturing company or buying stocks at a reduced price of a competitor that closes down.
Good Cash Flow
Making sure that a business has good cash flow and large revenue coming in in the next few days are essential before seeking a cash flow loan. If the projected revenue is not met within a certain period, the business might not be able to make the repayments on time or default on the loan. When this happens, the business might be charged with late payment fees. If the loan has a blanket lien, the lender can take control of the cash flows.
Lack of Asset to Secure a Loan
Cash flow lending may provide an ideal alternative for a business that seeks financing but doesn't want to pledge its valuable assets as collateral for the loan or doesn’t have any collateral at all.
How to Get a Cash Flow Loan
Getting approved for cash flow financing depends entirely on the lender. Generally, however, the chance of approval is high if a business can:
1. Present a good credit score
A good credit score generally means that a business is in good financial shape and its owner has been a responsible debtor in past. Thus, having a good credit score and credit record increase its chances of securing a cash flow loan.
2. Maintain good bank statements and a positive cash flow
Most lenders check a business’s latest bank statements and may even require a certain monthly bank account threshold before giving the approving nod. These bank records reflect the business’s cash flow and financial standing. Positive cash flow means more money is coming in than is going out, which reflects a capacity to repay the loan.
3. Generate enough sales daily
Aside from positive cash flow, a business has a higher chance of securing a cash flow loan if it generates enough sales daily, weekly or monthly, as reflected in the sales reports. Lenders see the business as profitable and capable of repaying the loan as agreed.
While a cash flow lending is easier to secure than traditional business loans, not all business owners get the lender’s approval and not all businesses that use cash flow lending are successful. Before applying for one, companies should first evaluate their financial situation and seek financial advice to make an informed decision.
Positive Lending Solutions provides various loan products to business owners across Australia. If you have a business crisis or project that financing can resolve, call us today on 1300 722 210 or request a Quick Quote now.