What is cash flow finance?

Cash flow is an essential element for any thriving business.

There may be instances when your business might need some additional financial support, especially during periods of irregular cash inflows or when facing delayed payments.

Should your company require an additional financial boost to manage its daily operations, a loan could be a viable option.

However, the availability of traditional bank loans may vary based on your credit history.

This is where cash flow finance can help.

In this article we’ll outline what cash flow finance is, the benefits and drawbacks of using it, and the differences between it and more traditional loans.

As with all financial products, before committing it’s a good idea to seek independent financial advice to check that the product is right for you and your business.

What is cash flow finance?

Cash flow finance (or cash flow lending) is a form of unsecured financing utilised by businesses to support their daily operations.

Typically, this type of loan is leveraged to fund working capital needs such as payroll, rent, inventory costs, and others.

The repayment of this loan is structured around your business's anticipated incoming cash flows, implying that you are essentially borrowing against future revenues.

In the context of business finance, it's crucial to recognise that cash flow finance is different from a traditional bank loan.

To access a traditional loan your business will need to undergo a comprehensive and time-consuming assessment of its financial status, including its credit history.

Conversely, the eligibility for cash flow finance is primarily determined by your business's ability to generate consistent cash flow.

How does cash flow finance work?

Cash flow finance is typically a go-to option for smaller businesses that lack the necessary assets to secure a loan, have no established history of profitability, or don't possess an extensive credit history.

Consequently, lenders may impose higher interest rates and set up fees for these loans.

It's crucial to repay cash flow loans promptly as missed payments can substantially strain your business's financial health.

For instance, consider a seasonal business, such as a company selling Christmas trees, which generates the majority of its annual sales between November and December.

During the summer months, this company might face reduced cash flow, making it challenging to cover payroll and rent expenses.

In such a scenario, they might opt for a cash flow loan.

Once their peak sales season arrives in winter, they can repay the loan, along with the accrued interest.

What are the differences between cash flow finance and traditional loans?

In a lot of ways, cash flow finance works the same as any other loan.

You apply for an amount of money you need to cover costs and then repay that amount with agreed upon interest.

However, there are some key differences between cash flow finance and more traditional loans.

Future revenue versus assets

Cash flow loans are a unique form of financing that primarily focuses on your business's anticipated future revenue rather than the assets you currently possess.

They are unsecured, meaning that lenders base your loan eligibility on your past and predicted cash flow.

Business performance versus credit score

One of the key aspects of cash flow loans is that your business performance can carry more weight than your business credit score.

While your credit score isn't entirely overlooked, lenders give more consideration to your past business achievements and projected future performance when deciding whether to approve your loan application.

Approval time

A significant advantage of cash flow loans over other types of loan is their speed of acquisition.

If you qualify for one, your application tends to be approved much quicker than a standard business loan, making it an ideal solution for urgent financial needs.

Short term versus longer term.

Unlike traditional loans, cash flow finance is intended for short-term use only.

Typically, repayment schedules range from one to 12 months, depending on the lender and the specific loan agreement.

Interest rates

It's important to note that cash flow loans often come with higher interest rates and fees than traditional business loans.

This is due to their unsecured nature and short-term repayment period.

Personal guarantees

Securing a cash flow loan may require the business owner to offer a personal guarantee.

This implies that if your business fails to repay the loan, the business owner, would be personally responsible for settling the remaining balance.

What are the advantages of cash flow finance?

There are a number of potential benefits to cash flow finance for a business.

Quick decisions

Securing cash flow finance can be a quick process.

However, it requires you to present certain documents to prospective lenders to prove your business's credibility and stability.

These may include financial statements, trading histories, and proof of a well-structured cash flow plan.

Some lenders might also conduct a credit check for further assurance.

It's important to illustrate that your loan application is a strategic move for cash flow management, rather than a consequence of poor planning.

Provided your business and its records meet the lender's criteria and are approved, the decision-making process can be expedited.

Following approval, the funds could be transferred into your account shortly thereafter.

No need for collateral

Unlike other debt products, such as asset finance, cash flow finance doesn’t require a physical asset (such as a property, piece of equipment or inventory) to be put up as collateral against the debt.

This potentially makes it more attractive to businesses which don’t possess the hard assets needed to back an asset-based loan or businesses with high margins on their balance sheet.

A poor credit rating isn’t necessarily a barrier

Although a good credit rating will certainly improve the chances of your business being approved for a cash flow loan, a poor credit rating isn’t necessarily a fatal flaw for your application.

If a business already has cash flow concerns, the lender will pay particular attention to the current situation.

If a company can demonstrate that it's likely to repay the loan without any issues in the coming months, a poor credit rating should not necessarily deter lenders from granting the loan or insisting on extra collateral.

However, it's possible that the loan amount provided may be less than initially requested, and the interest rate could be somewhat elevated compared to those with a healthier credit score.

Therefore, it's highly recommended for businesses to evaluate offers from various lenders.

Each lender assesses risks differently and provides unique terms for a cash flow loan.

This comparison can help businesses secure the most favourable conditions.

Can help boost a business credit score

By utilising cash flow finance effectively, particularly by repaying the loan within a brief time frame, it’s possible to enhance the credit rating of a business.

What are the disadvantages of cash flow finance?

As with any financial product there are potential limitations to cash flow finance, depending on the circumstances of your business.

High fees

Cash flow loans often come with notably high interest rates and sizable fees, supplemented by substantial penalties for delayed payments.

Prior to opting for a cash flow loan, it's crucial to assess your ability to manage these costs, particularly if there's a possibility of missing a scheduled payment.

The financial implications could be significant, so careful consideration is necessary.

Personal Guarantees (disadvantages)

Though cash flow loans don't require collateral in the form of specific assets, lenders may impose a general lien on your entire business as part of the loan terms.

A general lien refers to a creditor's legal right to hold or seize a debtor's property.

However, it's not just restricted to charges related directly to that particular property.

Instead, it also extends to cover debts owed on a broader account.

This means the creditor can use the property as leverage until the debtor settles their overall outstanding debts.

In relation to cash flow finance, this implies that your business effectively becomes the collateral.

Furthermore, you might be asked to provide a personal guarantee for the loan.

This makes you personally liable for its repayment, adding an extra layer of responsibility.

Find out more about personal guarantees with our guide.

Automatic payments

Certain lenders may stipulate automatic payments as a prerequisite for the loan.

This could pose a challenge for businesses experiencing fluctuating cash flow on a monthly, or even daily basis.

The automatic payment scheme could potentially lead to insufficient funds in your business account when the payment is due, causing financial strain.

Only for the short-term

Given the need to repay the money borrowed in a relatively short timescale of often less than a year, cash flow finance is only suitable for acute short term cash flow issues.

For businesses with longer term cash flow concerns other products may be more preferable.

Types of cash flow finance

In addition to unsecured cash flow finance, there are a number of other types of financial instrument available to business owners looking to alleviate pressure on their cash flow.

Invoice finance

If your business operations involve frequent invoicing to clients, invoice financing could be a beneficial option for you.

This financial arrangement allows you to secure funds against your outstanding invoices.

Invoice financing primarily comes in two forms: invoice factoring and invoice discounting.

With invoice factoring, your lender assumes the responsibility of collecting payments from your clients.

On the other hand, invoice discounting enables you to retain control over payment collection from your clients.

Read our guide to find out more about invoice finance.

Merchant cash advance

Should your business regularly process debit and credit card transactions, you might want to consider a merchant cash advance as a financing option.

In this arrangement, the lender provides you with a substantial upfront cash payment.

The repayment is then structured around a pre-determined percentage of your future debit and credit card sales until the total loan amount is fully repaid.

For more read our guide on merchant cash advance.

Revolving credit facility

A revolving credit facility could be an ideal option for your business if you're seeking more flexibility in your borrowing.

This type of credit arrangement, similar to a business line of credit, gives you the freedom to draw and repay funds as per your needs throughout the duration of your contract.

To learn more about revolving credit facilities, read our guide.