Cash flow is crucial in running a business. You can make all the money in the world, but without positive cash flow, it’s hard to cover expenses and grow the way you want to.
Even perfectly profitable businesses struggle with cash flow. It’s one of the most common reasons businesses go under, accounting for more than 80% of business failures.
Cash flow funding addresses this very issue, but there’s a few different forms and it can be difficult to know where to start. This is everything you need to know about cash flow loans.
Understanding cash flow loans
Cash flow lending is a type of unsecured borrowing that businesses use to cover day-to-day expenses and outgoings like rent, wages, purchasing inventory etc..
They’re different to typical bank loans in that they don’t have the same level of credit analysis of a business. Rather than securing the loan against assets, the business needs to show its capacity for generating revenue.
How does a cash flow loan work?
Cash flow loans are great solutions for small businesses or startups that struggle to satisfy the requirements of traditional lending. They may not have sufficient assets, or the credit history required to get a conventional bank loan.
From the lender’s perspective, this makes the loan more of a risk. The increased risk means businesses will tend to pay higher interest rates than with other borrowing.
Cash flow loans come with origination fees that are typically higher than with other lending, and often have higher late fee charges as well. All of these extra costs make cash flow lending an expensive source of finance. Businesses that take this route should plan to pay back their borrowing as soon as possible in order to reduce the cost involved.
To get a cash flow loan, businesses need to illustrate how they expect to receive money in the future. You may have projects in the pipeline, but bills to pay right now and not enough cash to cover the cost. This is where getting cash flow lending can help to improve cash flow in quiet periods and keep the business running until money from future work comes in.
Depending on the lender, and what your requirements are, businesses can typically borrow anywhere from $5,000 to $250,000.
There can be two different repayment options with cash flow finance solutions:
- Repayments can be a percentage of the business’ sales, or;
- They can be in fixed amounts over a set period of time
Asset-based lending vs. cash flow lending: What’s the difference?
When assessing whether to use cash flow finance or more conventional, asset-based lending, there are two main differences to be aware of.
As we’ve mentioned above, in cash flow lending, businesses don’t secure their borrowing against assets. Rather than using property, equipment or inventory as collateral, businesses stake their lending against expected future cash flows.
Cash flow is generally considered by lenders as a part of credit checking a business for asset-based lending, but it’s not given the same weight as the value of its assets.
That means cash flow finance is often easier for small businesses to get. Startups and smaller enterprises often don’t have the collateral to secure large asset-based loans against.
Similarly, different features of businesses make them more suitable for either asset-based or cash flow finance.
Businesses with large balance sheets, significant assets, or (ironically) less cash flow tend to be better suited to asset-based lending.
Cash flow lending is generally a better option for businesses with high margins and fewer assets.
Downsides of a cash flow loan
If you’re in a business that seems more suited to cash flow funding, it’s also worth being aware of its limitations. A cash flow loan does impact borrowers in a few key ways – these are some of the common downsides with cash flow lending:
As we’ve mentioned above, cash flow funding is generally a more expensive option than asset-based borrowing.
For example, Bloomberg Businessweek found cash flow lender OnDeck charged an average annual interest rate of 54%. At the same time, banks were charging between 7-9% and smaller lenders were offering 10-20% interest on asset-based loans.
As well as interest, lenders charge other fees for cash flow loans. Origination fees are around 2.5% the value of the loan, and late fees can be significant if, for whatever reason, you’re unable to make a repayment on time.
Liens and personal guarantee
While cash flow loans don’t involve using assets as collateral in the same way asset-based lending does, that doesn’t mean lenders have no rights to claim property. Cash flow lenders do require security in order to issue loans, but the way they do it is different.
Instead of securing loans against specific assets of an agreeable amount, businesses offer a general lien that can be used by the lender to claim assets that cover the outstanding balance.
A lien is a legal right that’s established by lenders to claim assets in the event that a borrower doesn’t meet their payment obligations.
What’s more, business owners need to sign a personal guarantee for the loan, which means they are responsible for repaying the debt even if the business can’t.
Adopting cash flow loans for your business
As a small business owner assessing finance options, it may seem that expensive short term cash flow loans are your only option.
However, you may be able to utilise invoice financing. At the very least, invoice financing can reduce the amount of expensive borrowing you need to do. At best, it may be a cash flow finance solution that means you don’t need to get a loan at all.
Invoice financing works by lending businesses the value of their invoices. Borrowing is essentially secured against invoices, and the effect is the same as if customers paid their invoices immediately.
This promotes healthy cash flow by enabling businesses to cover expenses and investment opportunities that fall between work being completed and money coming in.
For example, if wages are paid every two weeks and invoices are sent every month, that’s at least one round of wages that businesses have to use their cash reserves to cover.
When using FundTap for invoice financing, businesses link it to their online accounting software, so when customers pay their invoices, the amount is automatically direct debited to FundTap, plus a small fee.
FundTap is on demand and so you only use it when needed. With a single transparent fee that is only charged when you receive funding, you are in control.
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