Let’s imagine your business is a rocket, ready for launch. But there is one tiny problem – you’re low on fuel i.e cash. You’ll need a booster pack to launch your rocket, which in this case, is nothing but a cash flow loan that just might propel you to the stars. But is it the perfect boost or could it propel you into an orbit of debt?
According to a recent report, small-ticket financing is expected to grow at 25% YoY, with cash flow lending being at the helm of this significant growth rate. Under this method of financing, you can obtain loans quickly without having to put your physical assets on the line.
Wondering if it’s a suitable financing option for your company? Strap in and let’s find out if cash flow lending is the right spark for your business journey!
What is Cash Flow Lending?
Cash flow lending is a form of financing where lenders extend loans to businesses based on their cash flows. Think of it as a lender trusting in your ability to earn, and not just what’s in your wallet today. This form of lending offers more flexibility compared to traditional means that rely on your creditworthiness and collateral. Small businesses and MSMEs generally take up cash flow loans to fund working capital needs like rent, inventory, payroll, etc
Key Features of Cash Flow Lending
- Flexible Terms – The inability to pay off a loan on time is a situation you typically would not want to find yourself in. Unlike traditional loan types, cash flow lending lets you tailor your repayment schedules based on your business’ cash flows.
- Non-Collateral Based – Unlike traditional or asset-based loans that require collateral, cash flow lending solely relies on your company’s cash flows. Instead of tangible assets, lenders go through your cash flow history, projected earnings, and profitability to determine your creditworthiness. If you’re a tech startup or a service based organization with no substantial assets, then cash flow lending will be highly suitable.
- Focus on Cash Flow – Lenders care and put more emphasis on your cash flow statements. By analyzing cash inflows and outflows, they evaluate your ability to generate sufficient funds to repay the cash flow loan.
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Types of Cash Flow Lending Products
Working capital loans
These are small-sized, short-term loans that will cover your day-to-day expenses and current obligations such as purchasing inventory, payroll, GST payments, etc.
Buy Now, Pay Later (BNPL)
While shopping on eCommerce platforms, you may have come across the BNPL facility. When you’re about to purchase a product and can’t make an upfront payment, it will allow you to still complete the purchase on credit. Interestingly, this payment mode is widely used by customers, bringing the total revenue of the global BNPL market to $19 billion as of 2024.
Merchant Cash Advance
Under this type of financing, you receive a lump sum of cash upfront in exchange for a portion of your future sales. When your sales take a hit, MCAs will help you make ends meet temporarily. And for this, your ability to repay depends on your sales history.
Overdrafts
Did you know that you could make withdrawals from your bank account even with a negative balance? Thanks to overdrafts, it is entirely possible. Banks usually allow this to help customers address temporary cash shortfalls. But don’t get too attracted to it! It’s still a loan you need to pay off eventually.
Invoice Financing
Invoice financing is a credit facility that allows you to borrow money using high-value unpaid invoices as collateral. It requires no physical assets and no personal guarantees. Instead of waiting weeks or even months for your clients to pay their invoices, you can turn those unpaid bills into instant cash. This is an ideal funding solution if you’re looking to boost your firm’s cash flow and meet short-term expenses.
Supply Chain Financing
Also known as Supplier Finance, this form of lending helps both buyers and suppliers optimize their working capital by speeding up cash flow. Curious to know how it works? Here’s a quick rundown:
- The supplier delivers the goods to the buyer and submits an invoice.
- Instead of waiting for the buyer’s payment, the supplier receives an early payment from a bank or any other financial institution, often at lower interest rates taking the buyer’s creditworthiness into account.
- Finally, the buyer pays the amount to the financial institution on the agreed-upon date.
Revenue-based Financing
This form of financing is where businesses receive capital from investors in exchange for a percentage of their future revenue. Think of it as a win-win partnership! The investor bets on your business’ growth and you receive funds without the pressure of repayment schedules. Instead, they are flexible and are tied to your company’s performance. Payments increase when sales are high and they are smaller when sales are low. Revenue-based financing is popular with startups and subscription-based businesses looking to scale up without accumulating massive debts.
Line of Credit
Line of credit allows you to borrow money up to a set limit and repay it over time. It’s a highly flexible loan and the best part? You only pay interest on the amount you actually use. It’s a cycle where you can borrow, repay, and borrow again as needed. Looking to seize that new business opportunity? Or you simply might need to cover some unexpected expenses. Either way, line of credit will ensure your finances are controlled and that you have funds right when you need them.
Benefits of Cash Flow Lending
Cash flow loans can benefit your business and lender in the following ways:
For Borrowers
- Quick access to capital: Cash flow loans have faster approval times as the lending decision entirely depends on your business’ cash flow. Hence, no more worrying about delays.
- Flexibility in usage: Cash flow loans generally involve fewer restrictions on how the funds are used, granting you more freedom to allocate the funds wherever they’re needed. Planning to invest in some new equipment or renovate your office space? Cash flow loans grant you the freedom to do that.
- No need for physical collateral: If you’re a business operating with limited tangible assets, cash flow lending would be your best option as it doesn’t require physical assets to be given as collateral. In short, cash flow loans are collateral-free loans.
For Lenders
- Risk assessment based on cash flow: It is much easier for lenders to thoroughly analyze cash flow statements and they get a good picture of your ability to repay the loan. They give higher weightage to your cash flow data while also analyzing past performance, current financial health, and future projections.
Limitations of Cash Flow Lending
While cash flow loans may look attractive on paper, it still comes with its baggage of limitations that you’ll need to keep in mind:
For Borrowers
- Higher interest rates compared to traditional loans: So here’s the real kicker. While cash flow loans may be easier to obtain, you unfortunately have to bear higher interest rates compared to a traditional loan. Since they are unsecured with no collateral backing them, lenders are more vulnerable to non-repayment risks. This is why they impose higher interest rates and set up fees for these loans.
- Risk of over-reliance on short-term financing: Cash flow financing might seem like the most attractive loan option to fulfill your short-term operational needs, but it also comes at a price. Your business may face unsustainable debt cycles if you rely on them too much, leading to limited cash flows and the inability to close your debt. Sounds a lot like an addiction, right? Never take too many loans.
For Lenders
- Inaccuracies in cash flow projections: Although lenders may find it easier to analyze cash flow statements and projections, some uncertainties can make it trickier. Changing market conditions, and unforeseen expenses incurred by your business will lead to inaccurate projections, reducing their optimism and likelihood to move forward with the lending process.
- Risk of default: Since these loans are unsecured with no collateral involved, lenders face a high risk of payment defaults, especially in situations, when your company’s cash flows are poor. In this case, lenders may find it difficult to recoup their losses.
The Cash Flow Lending Process
You might be wondering how to apply for a cash flow-based loan and lucky for you, the process is quite simple:
Step 1 – Application Process
As with any type of loan, the first step begins with the application process, which requires meticulous attention to detail and proper documentation. To ensure a smooth application process with the lowest chance of rejections, you’ll need the following documents:
- Updated financial statements
- Cash flow statements
- Business Plan
- Cash flow projections
- Tax returns
- Legal documents
Step 2: Approval Process
Once you submit the above documents, the lenders will conduct a comprehensive analysis to determine your company’s financial health and ability to repay the loan. They may also assess your debt-equity ratios to understand your ability to handle additional debt. Since it does not involve any collateral, approval times are quick, lasting between 24 to 72 hours depending on the nature of the loan and documents submitted.
Step 3: Disbursement of Funds
Once the loan is approved, your funds will be disbursed to you within a few days. They will be transferred directly to your business’ bank account for immediate access.
Cash Flow Lending vs Asset Lending
Here are some of the key differences between asset lending and cash flow lending:
| Cash-Flow Lending | Asset Lending | |
|---|---|---|
| Criterion | EBITDA (earnings before interest, taxes, depreciation, and amortization) and cash flow are a common criterion. | Assets such as inventory, accounts receivable, property, and industrial equipment are a common criterion. |
| Suitability | Suitable for any business with a good cash flow. | Suitable for businesses with physical assets. |
| Collateral | Does not involve any collateral and relies on the company's capacity to produce consistent future income. | Involves collateral in the form of physical assets that can be held and used by the lender if the borrower cannot satisfy payment requirements. |
| Basis of Repayment | Repayment is possible only when the company has sufficient cash flows. | Repayment is based on expected income from the assets. |
The Bottomline
Thanks to cash flow lending, you do not have to worry about the burdens of extensive paperwork and collateral when receiving funds. You have more flexibility to manage your funds and repay the loan based on your company’s cash flow performance. Ultimately, understanding your cash flow patterns will be critical towards making informed decisions and deciding the ideal loan type you need.
And as a lender, having a robust loan origination system like CloudBankin can do wonders in analyzing the cash flow of a borrower and helping you with cash flow lending decisions based on real data. With our platform, you can streamline the lending and approval processes for your clients and simplify their funding journey. To know more, contact us today!
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