Everything to Know About Cash Flow Loans for Small Business

Cash flow is just as important as profit when it comes to the financial health of your business. Even if your company has high profits, extended payment terms and seasonal sales can cause cash flow gaps that restrict growth.

A cash flow loan can boost working capital and support growth without the need for real estate collateral. Unlike a traditional loan, cash flow lending is based on your future cash inflows, not on the value of the physical assets on your balance sheet.

Here’s everything you need to know to work out if a cash flow loan is a good idea for your business.

What Is a Cash Flow Loan?

A cash flow loan is a type of financing based on the projected and historical cash flows of your business. While a traditional asset-based loan requires security in the form of property or high-value assets, a cash flow loan does not require any physical collateral.

There are different types of cash flow lending, but they all primarily involve using your projected sales revenue as a way to secure immediate funding.

How Do Cash Flow Loans Work?

In simple terms, cash flow loans enable you to borrow money based on your future earnings. If your business experiences cash flow gaps due to seasonal sales or extended payment terms, a cash flow loan can be a way to increase working capital quickly.

One of the most popular and well-known forms of cash flow lending is Invoice Finance. With an Invoice Finance facility, you can access the money owed to your business by unlocking the capital tied up in your outstanding sales invoices.

Rather than waiting for your customer to pay, you can submit your invoice to the finance company and get a cash advance of up to 95% of the invoice value upfront. Once your customer pays the invoice, you receive the remaining balance of the invoice less fees.

Invoice financing is technically secured by your accounts receivable and not your projected cash flow. But your outstanding invoices are the only collateral you need to secure funding. You don’t need to use your home as security.

Cash Flow Lending vs. Asset-Based Lending

Both types of financing can raise the capital you need to grow your business and achieve your goals. You may find that a combination of asset-based and cash flow lending offer the long-term affordability and short-term flexibility you need to fund the growth of your business.

With asset-based lending, the amount of money you can borrow is based on the value of the assets you are willing to use as collateral. Traditional asset-based lending like secured loans can be difficult to access if you don’t have real estate to use as security. Over 50% of secured business loans in Australia are secured with residential property.

With cash flow lending, the amount you can borrow is based on the projected cash inflows your business will generate in the future. The lender is less concerned about the value of the assets on your balance sheet and more interested in your ability to repay the principal and interest of the loan.

In general, asset-based lending is more suited for long-term borrowing. Cash flow lending is more flexible and suitable for short-term working capital needs.

Pros and Cons of Cash Flow Financing

As with all business funding solutions, there are advantages and disadvantages to cash flow financing:

Pro – Fast Cash Injection
Because there is no asset valuation required, cash flow lending can help you quickly raise capital to cover cash flow gaps or take advantage of opportunities. With Invoice Finance, you can access funds within 24 hours of submitting an invoice.

Pro – Avoid Long-Term Debt
Instead of loading debt onto your business, you can release the capital tied up in your accounts receivable. Invoice Finance allows you to boost your cash flow without locking you into a lengthy repayment schedule.

Pro – Easy to Access
Invoice Finance is much more accessible than a traditional asset-based secured loan. Even if you have a short trading history, poor credit score, or lack high-value assets on your balance sheet, you can still qualify for an Invoice Finance facility.

Pro – No Property Security
You don’t need to use your home as security. With a secured business loan, you risk losing your home if you are unable to make repayments.

Con – Reduced Profits
One of the most important considerations for a cash flow lending facility is that you will reduce your profit margin. When you submit an invoice for financing, the funding provider will usually charge a fee based on a percentage of the invoice value. If you rely on high volumes and low margins, Invoice Finance may eat into your profits.

Con – Credit Limit Based on Invoice Value
Cash flow lending credit limits are based on the value of your sales revenue. If you need a large lump sum to cover a significant expense, Invoice Finance may not provide the total amount you need. If you’re looking to cover a one-off business purchase cost, Equipment Finance may be a more suitable funding option.

Is Cash Flow Finance Right for Your Business?
Many growing businesses encounter working capital issues when they take on new customers and enter a period of rapid growth. Cash flow financing can be an effective funding solution if your business suffers from cash flow gaps due to extended payment terms or seasonal sales.

One of the best ways to identify and prepare for potential working capital shortages is to create a cash flow forecast.

Read our step by step guide if you need help to create a cash flow forecast for your business.

It can also be a good funding option if you need a quick cash injection to cover an unexpected expense or capitalise on a time-limited opportunity. According to the latest Australian Bureau of Statistics latest data, 41% of SMEs report cash on hand would not cover more than three months of business operations.

If you need fast access to funding, cash flow funding can help.

How Much Does Cash Flow Finance Cost?

The cost of an Invoice Finance facility depends on the amount of risk involved for the funding provider. The finance company will look at the value and volume of your invoices, the creditworthiness of your customers, and other factors when determining the cost of the facility.

Generally, the more invoices you finance and the more creditworthy your customers, the lower the cost.

The cost of cash flow Invoice Finance also depends on the type of facility. Invoice factoring is usually more expensive as it involves collections being outsourced to the finance company.

Invoice Discounting is typically less expensive, but you will need an established collections and account management team to collect payment from your customers.

You can find out more about the different types of Invoice Finance by checking out our guide Invoice Discounting vs. Factoring.

How Long Does It Take to Secure Cash Flow Finance?

The application process is much faster than a traditional bank loan. If your financial records are up to date, a facility can be approved within days of your application. Once your invoice has been approved for funding, you will receive a cash advance in as little as 24 hours.

Cash Flow Financing With ScotPac

Cash flow financing can be an important tool for managing working capital and supporting business growth. It’s a flexible funding solution that allows you to unlock the true value of your business, not just the value of the assets on your balance sheet.

If cash flow finance sounds like it could help your business, fill out an online application or speak to one of our friendly business finance advisors today. We’ll help you understand your options and create a tailored solution that’s right for your unique circumstances.