Cash Flow Financing the Right Way

See if a loan not backed by collateral is right for you

Are you a small business owner who needs funding for your company? Are you lacking collateral to qualify for a loan? Cash flow financing could be a solution for you. 

This guide provides the information needed to decide if a cash flow loan makes sense for you and, if so, how to get the right one.

• Cash flow financing: The basics
• How do small businesses document cash flow for loans?
• How do businesses project cash flows?
• What’s the difference between a cash-backed and asset-backed loan?
• Pros and cons of cash flow loans
• How to get a cash flow loan

Cash flow financing: The basics

Cash flow financing is a type of small business loan. A funder makes a loan to a company backed by its projected cash flows. Businesses that practice careful cash flow management are usually approved for this type of financing.

Definition: Cash flow is the amount of cash that flows in and out of a small business during a defined period.

Cash flow financing, often referred to as a cash flow loan, leverages the future cash flow of a business as an indicator that it can pay back the loan. Cash flow loans are attractive to small businesses that generate a large amount of cash from their sales but don’t have much in the way of physical assets, such as vehicles or equipment, which would typically be used as collateral to back the loan.

If a small business has significant positive cash flow, it signals to lenders that it generates enough cash from its revenue to meet its financial obligations. Negative cash flow, usually due to low sales or high operating expenses, indicates an inability to repay the financing. Banks and other creditors carefully review a company’s cash flow to figure out how much credit to extend.

Cash flow financing can be either short-term or long-term, providing flexibility to serve many business needs. Small businesses use funds from these loans to manage financial emergencies, as working capital, to take advantage of opportunities, or make significant purchases.

Businesses that get cash flow financing are essentially borrowing against a portion of the cash they expect to generate in the future. Banks, online lenders, or other creditors provide a payment schedule based on the cash projections of the business as well as historical cash flows.

How do small businesses document cash flow for loans?

A business cash flow statement (CFS) reports operating cash flow (OCF or cash flow from operations). The statement records the net income (net operating income) for a period of time. You calculate net OCF by removing the expenditures (cash outflows) required to run the business, such as bills paid to suppliers, rent, and insurance companies, from the income generated from sales (cash inflows). 

The cash flow statement for a given period also records investments in the company (such as purchasing machinery and equipment) or securities or other financial investments. A cash flow statement records financing and loan activities, such as raising money through short-term and long-term debt, taking on investors, or issuing bonds. Finally, the statement records the net amount of cash generated or lost for the period.

Be aware that cash flow from operating activities is considered by lenders. Cash flow from investing activities and cash flow from financing activities are not.

The bottom line: The more free cash flow your business has, the more financing you’ll likely qualify for.

How do businesses project cash flows?

Two factors critical to any cash flow projection are the accounts receivable and accounts payable of a company.

Definition: Accounts receivable is money owed by customers for goods and services sold by a business that could be collected in 30, 60, or 90 days.

Put simply, accounts receivables are future cash payments to a business for goods and services sold today. Banks or creditors use the anticipated receivables due to be collected to help project how much cash could be generated in the future.

Definition: Accounts payable are short-term debt obligations or liabilities, such as money owed to suppliers, utilities, and lenders.

The net cash generated from receivables and payables can be used to forecast cash flow. The amount of money expected to be generated is used by lenders to determine the loan amount.

Different lenders have their own guidelines on how much positive cash flow a business must have to be approved for a loan. They may also have minimum credit rating requirements based on the company’s outstanding debt and history of paying off its loans and other obligations. The business owner’s credit rating and the company credit rating could be checked to ensure both have a solid history of paying back debts. 

What’s the difference between a cash-backed and asset-backed loan?

Cash flow financing is significantly different from asset-backed loans. Asset-based financing helps small business owners borrow money. The loan is backed by assets owned by the business. Assets used as collateral could include equipment, inventory, machinery, land, or company vehicles.

Lenders place a lien on assets used as collateral. If the business defaults on a loan, meaning it cannot make principal and interest payments, the lien makes it easy for the lender to seize the assets legally.

Small business owners may also be required to use personal assets to back a loan or make a personal guarantee. Similar to business assets used as collateral, lenders can seize personal assets if the loan’s not paid back. 

Cash flow financing works in a similar fashion in that the expected cash earnings are used as collateral for the loan instead of physical assets. 

Companies that use asset-based financing have significant fixed assets, such as manufacturers, while companies that use cash flow financing are typically those that don’t have much in the way of assets, such as retail or service companies.

Pros and cons of cash flow loans

Pros

• Relatively fast source of funding. If you need cash quickly, some lenders offering cash flow financing can approve applications and deposit funds in your business bank account in less than one day. Be aware that traditional loan providers and lenders may take weeks or even months to issue financing. However, most cash flow loans are approved and cash is available in a few days.
• Simple application process. Alternative lenders usually issue cash flow financing. These types of lenders typically provide a streamlined online application process. You will most likely complete and submit a simple application in less than an hour, with minimal documentation required. Most online lenders use technology to underwrite your application. This requires you to connect your financial accounts to their online platform. This is less cumbersome than having to submit documents.
• Flexible requirements. Cash flow lenders heavily weigh your historical and projected revenue and expenses when reviewing your application. They’re typically more flexible than traditional business lender requirements. Unlike more standard loans, startups, businesses with bad credit, and those with few tangible assets may qualify. However, those with cash flow problems usually won’t make the cut.
• No physical collateral is required. You don’t need to put up physical collateral, such as equipment, real estate, machinery, or vehicles, to back a cash flow loan. Asset-based lenders are different. They will require physical property as loan collateral.

Cons

• Cash flow financing is expensive. Because of their less diligent underwriting process and no collateral requirements, cash flow loans are riskier than many other types of business loans. To mitigate this risk, lenders typically charge higher interest rates and fees. They can come with anywhere from a 10 to 99 percent annual percentage rate (APR). Read all documents carefully before accepting cash flow financing.
• Frequent regular payments. Cash flow loans usually come with short terms and require frequent repayments, often daily or weekly, instead of monthly. The payment schedule can have a significant impact on cash flow. It’s often challenging to manage, especially for seasonal businesses or those that need money to fill a cash flow gap. The frequent payments combined with high-interest rates can trap you into a cycle of debt you may not be able to get out of.
• Personal guarantee requirements. You won’t need to secure your cash flow loan with physical business collateral. However, most lenders will require you to sign a personal guarantee, which means you’ll be forced to repay your loan with your own assets if your business can’t make payments.

How to get a cash flow loan

Follow these steps to get cash flow financing.

• Determine your financing needs. Figure out how you will use your loan, how much cash you need, and how quickly you need access to funds. You should be able to use your bookkeeping or accounting software to figure out how much money you need.
• Evaluate your business cash flow and other factors. Look closely at your historical revenue, projected revenue, cash position, and other financial data. Check your credit score, even though it may not be as significant a factor as for more traditional loans. Lenders won’t loan money to people or businesses with bad payment histories or poor net cash flow.
• Research and compare lenders. Check out several online lenders to find the best one for your small business. Consider interest rates, repayment terms, funding speed, the application process, customer service, lender reputation, and ratings and reviews.
• Complete and submit your application. Cash flow lenders usually provide simple online applications. They can generally be completed in less than an hour. You shouldn’t need too much documentation, but you may be asked to provide the following:
  • Personal and business tax returns
  • Statement of cash flows
  • Personal and business bank statements
  • Business financial statements (e.g., profit and loss statement, income statement, or a balance sheet).

You’ll also likely be required to sign a personal guarantee.

• Read your loan agreement carefully. Thoroughly review your loan agreement before signing it. Make sure you understand the interest rates and repayment terms. Look out for unexpected or high fees.
• Get funding. If you use a direct method, you’ll get funds deposited into your business bank account quickly, often in as little as one day.

If you have any questions or concerns about your agreement, ask your lender. If they refuse to clarify anything, move on to a lending company that’s more honest and straightforward.