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What Is Cash Flow Lending?

July 27, 2020

Cash flow lending is one form of business finance that can help small businesses get the funds they need. Here we’ll define this type of funding and how it compares to its alternatives.
This article originated from the Xero blog. The XU Hub is an independent news and media platform - for Xero users, by Xero users. Any content, imagery and associated links below are directly from Xero and not produced by the XU Hub.
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Cash flow-based lending

Cash flow-based lending makes it possible for business owners to borrow money based on a company’s past and project future cash flow. Basically, a company borrows money based on the revenue it’s projected to receive in the future. Other factors, such as credit ratings, are also considered when making a lending decision. EBITDA (earnings before interest, taxes, depreciation and amortisation) is one of the financial metrics used to make a lending decision.

For instance, a company with a working capital shortage might not have enough money to cover its short-term payroll obligations could consider cash flow lending to cover these expenses. When the cash flow from sales improves, the business can repay the loan, plus any interest.

The advantage of these types of business loans is that a business can get finance much faster because no collateral is required. With no security attached to the loan, the interest rates are usually higher for unsecured business loans. For this reason, cash flow loans are more suitable for companies with high profit margins and don’t have assets to offer as collateral for business finance.

Types of cash flow lending

There are several forms of cash flow lending, including term loans and lines of credit. With a term loan, there are regular set payments over a predetermined period (term) of the loan. For example, Moula business loans have terms from six months to two years.

A business line of credit gives the business access to a predetermined amount of funds. The business only pays interest on the amount drawn from this finance facility. For example, if the business line of credit has a limit of $100,000 and $60,000 of this is being used, the borrower will only pay interest on that amount. As a revolving line of credit, repayment is flexible, so it can be adjusted according to the cash flow position of a business.

Asset-based lending

This form of lending differs from cash flow lending in that the lender uses assets as collateral in the event of default.

One form of asset-based lending is invoice finance. With this form of finance, invoices are used as a form of collateral. The lender provides finance based on a percentage of the value of the outstanding invoices. For example, some invoice finance lenders provide 80 per cent of the value of the outstanding invoices. The loan is repaid when the invoices are paid. In some cases, the lender will take over the collection of the outstanding invoices.

Some forms of equipment finance are classified as asset-based lending. With these types of asset-based loans, lenders use the equipment or machinery being purchased as collateral. If the business isn’t able to repay the loan, the lender can repossess the asset and sell it to recoup the money it lent. At the same time, businesses investing in new equipment don’t have to come up with additional collateral with this type of finance.

Buy now, pay later for business

With this form of finance the merchant gets paid up-front and the purchaser is able to extend the payment terms. Although more common for business-to-consumer finance, buy now pay later (BNPL) is becoming more popular for business-to-business transactions. With Moula Pay, for example, the approved merchant gets paid immediately for the purchase. The purchaser gets a three-month interest-free and repayment-free period, plus an additional nine months to repay the outstanding balance.

Why leave it there?

Learn more about the benefits of buy now, pay later for business-to-business transactions.

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