Throughout the lifecycle of any business, there’s a high chance you’ll encounter cash flow issues. For whatever reason, this will mean looking elsewhere for a cash injection to help get you through.
Cash flow lending is designed specifically to help businesses through these times, but can come with fish hooks and issues worth being aware of before you lock yourself into it.
Cash flow lending, while effective, can be expensive and puts businesses at risk if you can’t meet repayments. Invoice financing is a great way to promote positive cash flow, even if it’s just to reduce the amount of borrowing the business has to take out.
What is cash flow lending?
Cash flow lending is available to businesses to cover day to day operating expenses such as wages, rent and the purchase of inventory.
A cash flow loan is a form of unsecured lending, which means it doesn’t rely on business or personal assets as collateral. This sets it apart from conventional business lending.
Cash flow funding doesn’t come with the same level of scrutiny over a business’s financial health. Lenders won’t put the same level of attention into assessing your credit history or past balance sheets.
As a form of short term lending, eligibility almost solely comes down to the business’s ability to make money in the near future and repay the balance that way.
How does cash flow lending work?
Cash flow lending is a popular form of finance for small businesses and startups that are unable to secure a traditional business loan.
You may not have the assets to secure a loan against, or a sufficient credit history, or a track record of profitability. All of these things are generally relied on by lenders in order to give a loan.
However, while this makes cash flow finance easier to get, it will cost you. Because the bar is lower, it’s considered more risky by the lender. Interest rates will be higher, and the origination or establishment fee will be more than other types of loan.
Cash flow lending is particularly useful in businesses where cash on hand ebbs and flows. Most businesses will have varying levels of cash just across the course of each month and ensuring they have the cash on hand when needed can be challenging. Another example is seasonal businesses that have high peak seasons and periods of much lower activity.
In the quieter months, or periods within each month, the business may not have the cash on hand to cover overheads such as rent, utility bills or wages. It can borrow against its future earnings from the upcoming busy period in order to cover these costs.
Similarly, if a business is eyeing expansion or a new piece of equipment that will increase its production, it can look to cash flow funding to finance these purchases so it doesn’t kill cash flow that’s needed to meet ongoing operational needs.
Limitations of cash flow lending for businesses
Cash flow lending has the advantage of being a more accessible form of finance, particularly for small businesses and startups. However, limitations also include:
High fees refers to much more than just above average interest rates. As mentioned, there’s an origination fee as well as regular account fees and significant late charges if you miss payments.
Missed payments are not uncommon among cash flow borrowers, particularly because they’re taking out a loan at a time when the business’s incomings tend to be less than normal or unpredictable.
If your cash flow projections are off, there’s a very real chance you may not be able to meet a repayment.
While a cash flow loan isn’t secured against your assets, that doesn’t mean the lender has no right to claim items if you default on the loan. In fact, its claim can be even further reaching than normal.
Lenders can place what’s called a general lien on a business, which means the entire business will serve as collateral if needed. As the business owner, signing the loan agreement also makes you personally responsible for repaying the debt.
While these guarantees are also typical of bank funding and term loans, this is something you need to be aware of.
Lenders require businesses to repay cash flow loans through regular automatic payments, often every week. If the business doesn’t have the funds in the account for any reason, it’ll result in a missed payment and a late fee.
This may not be an issue, but if business fluctuates between busy periods and down times, you’ll need to pay close attention to your bank balance to ensure you can make each repayment. Businesses that take out cash flow lending do tend to be more variable, which may make this a more likely situation.
Asset-based lending vs. cash flow lending
There are a few key differences between lending on asset-based and cash flow lending.
One big difference, as we’ve mentioned, is the collateral is different. As the name suggests, asset-based lending is secured against assets such as property, equipment or inventory, while cash flow lending is based on expected future income.
Future cash flow is also considered by lenders when assessing asset-based lending, but not to the same degree.
Asset-based lending tends to be better suited to larger organisations with bigger balance sheets and assets that can serve as collateral. It’s also a good option for companies that don’t have significant cash flow.
Cash flow lending is a better option for businesses with higher margins, or smaller businesses that don’t have valuable assets to secure a loan against.
Read more: Lending on invoices vs cash assets
5 financing solutions to improve business cash flow
Aside from cash flow lending, there are a range of other cash flow finance solutions you can use. It pays to consider all your options before determining the best for you – it may be that the best solution is a combination of two or more strategies.
Obtain short-term loans for working capital
Short term loans are easy to get approval for and quick to action, with some lenders able to deposit funding the very next day. While they often come with above average interest rates, the cost can end up being lower than with other borrowing because you’ll pay it back faster.
Use small business lines of credit
A small business line of credit is like a credit card. Businesses can get approved for a certain amount of borrowing, and you’re charged interest on the outstanding balance – not the whole amount of credit. However, there is often an additional undrawn fee of the full facility.
Encourage faster repayment of invoices
The sooner your customers pay their invoices, the better your cash flow will be. This is about finding a balance of what’s reasonable – telling customers invoices are due in a couple of days probably won’t go down that well.
There are a few ways you can do this:
- Auto billing sets regular customers up to make payments on the same day each month, which creates regularity and predictability.
- Accepting online payments is something all businesses should be doing already – it makes it much quicker and easier for customers to pay invoices.
- Incentivise early payment/penalise late payment. Offer an early payment discount, or charge late fees on overdue invoices.
- Allowing customers to choose their payment days not only helps to accommodate their preferences, but it means they don’t have an excuse to miss payments. Different businesses have different preferences – whether it’s to pay at the beginning, middle or end of the month.
Use invoice financing
Invoice financing is another way to effectively get invoices paid faster, but it works slightly differently. Invoice cash flow finance works by using a specialist service to lend the value of your invoices, which is repaid when customers pay their balance.
You can essentially get invoices paid straight away, with services such as FundTap able to transfer invoice finance the very same day you apply. This makes it one of the quickest cash flow finance solutions.
Read more: Invoice cash flow tips
Take home message
Invoice financing is perhaps the best option for businesses looking to eliminate or minimise the amount of cash flow lending they need to take out.
You don’t have to choose one option or another – in fact, elegant cash flow solutions use multiple techniques alongside each other. Invoice financing is particularly effective in complementing other strategies to provide better cash flow while keeping costs down.
For example, if you need $170,000 in cash flow lending, and you have $40,000 in invoices owing, rather than borrowing the entire $170k, you can use invoice financing to reduce the amount you need to borrow from the bank. This can save you months, or even years, of loan repayments. It’s also much more flexible than a term loan.
Invoice financing with FundTap has been designed to be quick and easy, with businesses able to get approved for borrowing, apply for funding and get the finance all in the same day.
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