Consider cash flow financing when your business needs capital
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What is cash flow financing? With cash flow financing, the business receives a loan, but the loan is backed by the expected cash flow of the business. A company’s cash flow is the amount of money flowing from and to the company over a period of time. Cash flow financing or a cash flow loan uses the generated cash flows to repay the loan.
If a business is generating positive cash flow, it means it is getting enough cash out of revenues to meet its financial obligations. Banks and lenders test for positive cash flow to determine how much loan they are willing to make.
You can get both short and long term cash flow loans. Companies can use this type of financing if they want to finance a business, buy another business, or make other major purchases.
The idea is that companies borrow for a fraction of the future cash flow they expect. Banks or creditors prepare a repayment schedule. They base this schedule on projected future cash flows and historical cash flow analysis.
Associated with: Tips for managing cash flow financing
Why look for cash flow financing?
The company may experience a temporary decline in cash flow. This could be due to less than outstanding seasonal sales. The company may incur unexpected expenses. Starting an expensive new project can create a cash flow gap.
A decrease in cash flow can also result from taking advantage of a time-limited opportunity, such as buying equipment at a large discount. Businesses can also suffer a drop in cash flow when they need to make emergency repairs to critical equipment.
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Cash flow statements
All cash flows are reported in a so-called company cash flow statement or CFS. This statement records the company’s income or net profit for the period covered by the statement. The statement calculates the operating cash flows from the expenses arising from running the business. These include vendor bills paid by the company. It also includes operating income from sales. The statement also mentions any investment activities.
Investing activities include investments in securities or in the company itself, for example the purchase of equipment. The statement records all financial activities, such as raising capital through a loan or even the issue of bonds. The bottom of the cash flow statement shows the net amount of cash generated or lost over the period.
Cash flow forecasts
The company’s payables and receivables will be two important areas in any cash flow forecast. The bank must take into account the obligations. These are short-term debt obligations, such as money owed to suppliers. The bank may use net cash from liabilities and receivables to forecast cash flows. Banks use this amount to determine the size of the loan.
The bank will also have to consider receivables. Accounts receivable serve as the future cash flow for the goods and services that the company sells today. Banks or lenders will use projected debt collection amounts to help determine how much cash will be generated in the future.
Banks may require a minimum credit rating for a firm’s outstanding debt in the form of bonds. Companies issuing bonds are assigned credit ratings. In this way, the level of risk associated with investing in the company’s bonds is weighted.
Cash flow loans versus asset-backed loans
Asset-based financing helps companies borrow money. However, an asset on the balance sheet serves as collateral for the loan. The bank pledges all assets serving as collateral. Assets used as collateral may include inventory, machinery, real estate, company vehicles, etc.
If the company defaults on an asset-backed loan, a bank lien allows the lender to legally seize the assets. Consequently, the business may lose its ability to function.
With cash flow financing, the generated cash serves as security for the loan. The security is not in the form of tangible or fixed assets. Typical companies that use cash flow financing often do not have many assets, such as service companies. See: investopedia.com/terms/c/cash-flow-financing.asp.
Flow-through loans provide a balance between the size of the loan, the APRC, and the length of the application process. Compare this to the many unsecured online loans that can take very quick approval but limit the loan amount. In addition, they tend to charge very expensive APR.
Cash flow financing can also be an improvement over traditional financing. Traditional banks offer larger loans, often over a million dollars, and lower APR, but it can take months to fund your account.
Often the company has to operate for several years. The borrower may need to meet a certain minimum credit rating requirement. They also need to prove historical cash flows and show receivables and payables so that the loan originator can determine the amount to be released.
Cash flow finance allows entrepreneurs to borrow money for future cash flows. It is usually used for temporary needs such as quickly purchasing equipment or starting a new project. This can be a good solution for service industries with little traditional security.
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