Cash Flow Lending for Small Businesses

Many small businesses need a cash infusion to keep operations running smoothly in the early stages. Often, these businesses rely on external funding so they can maintain a positive cash flow and fund essential expenses.

One problem? Most small and new companies struggle to qualify for traditional bank loans.

This is where cash flow loans come in handy. As an alternative financing solution, cash flow lending allows small business owners to access funding despite—for instance—a lack of hard assets, nonexistent credit history, or low revenue.

With this in mind, continue reading to learn more about cash flow loans, how they work, some examples of cash flow lending, and how cash flow loans differ from asset-based loans. Then, you’ll feel comfortable in determining whether or not cash flow lending is the perfect solution for your company.

What Is a Cash Flow Loan?

The term cash flow loan refers to a type of unsecured loan that is issued by a lender based on a small business’s projected revenue. This means that a loan based on cash flow prioritizes your business’s expected cash flow generation over your credit score.

With a cash flow-based loan, business owners can get the funding they need for the same kinds of expenses a typical bank loan would cover. This could include:

• Purchasing new inventory
• Covering payroll
• Taking on new business
• Managing ongoing expenses such as rent and insurance
• Dealing with temporary issues that might cause negative cash flow, like an off-season slowdown.

How Does Cash Flow Lending Work?

Cash flow lending for businesses works a little differently than a traditional loan, mainly because lenders focus on your future cash flow projections and revenue rather than factors like your existing credit score or assets. The loans themselves can be structured like a standard loan, line of credit, or merchant cash advance.

You’ll need to provide proof of your business’s revenue to get a cash flow loan. If you’re a new business, you’ll need to provide detailed projections as part of your business plan. Lenders will look at your historic performance and projected cash flow when deciding how much to lend to you and at what interest rate.

Small business cash flow loans are then repaid either as a fixed or variable deposit or as a percentage of your credit and debit sales. Repayment terms will vary from lender to lender, but repayments could be made weekly or even daily over a one to two-year period.

Why Do Small Businesses Choose Cash Flow Lending?

A business cash flow loan makes sense for small businesses that aren’t likely to qualify for a traditional loan. If you’re a new business or don’t have a strong business credit history, you may not be able to qualify for a traditional loan at all. Cash flow lending ensures you’ll still be able to get the money you need to fund your operations.

In addition, cash flow lending is often quick to fund. Streamlined applications, no requirements for physical collateral, and the availability of online lenders who offer these loans make them more accessible to small businesses.

Potential Downsides to Cash Flow Loans

While a cash flow bank loan may be helpful to some small business owners, there are also some potential downsides to be aware of.

First, because a cash flow loan is unsecured, lenders often require a personal guarantee. This means your personal assets could be claimed to repay the debt if your business defaults on the loan. Alternatively, they may place a lien on your business. Many lenders also charge higher origination fees, late fees, and so on because of the perceived extra risk of a cash flow loan.

In addition, cash flow loan interest rates are often higher than a traditional bank loan. Interest rates often start at 20%, which means your interest charges will be much higher over the life of the loan.

Cash flow loan repayment terms can also become an issue for some. Cash flow lending typically offers loan terms of just one to two years. In addition, repayments may be required weekly or even daily rather than monthly. Frequent payments combined with a high interest rate can make it more difficult to manage your cash flow.

Asset-Based Lending vs. Cash Flow Lending

Cash flow lending is quite distinct from asset-based lending—though both involve risk for small business owners. While cash flow lending involves an unsecured loan, asset-based lending is secured by inventory, accounts receivable, or even physical assets like real estate and equipment.

With asset-based lending, lenders are focused on the business’s current balance sheet and the value of the items that can be used as collateral. This collateral minimizes risk to the lender, which can result in more favorable loan terms.

On the other hand, cash flow lending is more concerned with a company’s projected results since repayment will come from the future cash flow you generate.

Cash Flow Loan Examples

There are several types of cash flow loans you could use to improve your cash flow, as well as some other alternative lending options that might be a better fit for your business.

Short-Term Business Loan

Short-term cash flow loans operate more like traditional bank loans. Your business receives a lump sum up front that you can use to cover your expenses. Depending on the terms of the loan, you’ll make fixed repayments on a monthly, weekly, or bi-monthly basis. Loan terms usually range from one to two years, meaning you’ll need to pay off the loan relatively quickly. You can expect higher fixed payments than with a traditional bank loan.

SBA loans are sometimes thought of as cash flow loans, but they really operate more like traditional bank loans. SBA cash flow loans are repaid monthly from your existing cash flow. However, the SBA approval process has a greater focus on creditworthiness. In addition, they offer loan terms of up to 60 months and lower interest rates than you would find with a true cash flow loan.

Line of Credit

A cash flow line of credit gives small businesses a revolving credit line that can be drawn upon as needed, up to the limit established by the lender. The maximum credit limit will usually be determined by your projected cash flow. Interest payments are made on the amount of credit that is withdrawn. Business owners essentially replenish their available credit as they pay off their existing balance.

Similar to a credit card, many business lines of credit only require a minimum payment on the withdrawn balance, but any funds that aren’t repaid will accumulate extremely high interest payments. Interest rates on a line of credit are usually higher than on a short-term business loan.

Merchant Cash Advance

Like a short-term business loan, a merchant cash advance (MCA) provides a lump sum loan upfront. However, these cash flow loans differ in their repayment structure. The lender takes a percentage of your daily credit and debit card transactions plus an additional fee based on your interest rate. MCAs also tend to have much higher interest rates than other cash flow lending options.

Because a merchant cash advance results in daily withdrawals from your accounts, it can become more difficult to manage your cash flow. This is why many small businesses look for MCA alternatives rather than move forward with an MCA.

Invoice Factoring

If you’re looking for lower-risk cash flow loan alternatives, invoice factoring could be the right solution for your small business. Like fast business cash flow loans, invoice factoring allows you to get the funding you need quickly—but without the high interest rates and shortened repayment terms.

With invoice factoring, you sell your outstanding accounts receivable to a factoring company in exchange for a cash advance. They will typically provide 80%-90% of the value of the invoice up front. The remaining value of the invoice is paid after your client makes their payment to the factoring company (minus the factoring company’s service fee).

While this reduces the total payment that you receive from the invoice, invoice factoring is not a loan. Essentially, it is a way for you to get early access to the payments your own clients owe you. You don’t take on any debt or have to put up assets for collateral. Approval is based on the creditworthiness of your client.

If you don’t have outstanding invoices you can sell to a factoring company, this won’t be an option. But invoice factoring can be a great solution if you’ve been dealing with cash flow problems due to customer payment habits.