Updated on 25th November 2024
Cash flow is critical for the financial health of a small or medium-sized business. In fact, when it comes to sustainable success, cash flow is equally as important as profit.
Even a profitable business can experience cash flow gaps that hinder growth due to factors like extended payment terms and seasonal sales cycles.
A cash flow loan can enhance and increase access to working capital and facilitate growth without requiring real estate collateral. Unlike traditional business loans or bank loans, cash flow lending uses projected future cash inflow as security rather than the value of physical assets on your business’s or personal balance sheet.
Loan facilities with this level of flexibility are particularly beneficial in a marketplace where the majority of businesses (60% by recent estimates) fail within the first three years. Especially considering that most of these failures are due to cash flow issues and other financial mismanagement.
So, what do you need to know to determine if a cash flow loan is the right option for your business?
Understanding Cash Flow Loans and Invoice Finance
What Is a Cash Flow Loan?
A cash flow loan is a finance option that relies on your business’s projected and historical cash flow to assess eligibility and determine loan suitability. Various types of cash flow lending exist, but they all fundamentally utilise your anticipated sales revenue to secure immediate funding.
Unlike traditional asset-based loans, which require collateral in the form of property or high-value assets, cash flow loans don’t require physical collateral. This is why they are an attractive option for businesses looking to maintain flexibility in their financing without compromising much-needed access to cash flow.
How Do Cash Flow Loans Work?
In essence, cash flow loans allow you to borrow money against your future earnings. If your business faces cash flow gaps due to seasonal fluctuations or extended payment terms, these loans can quickly boost your working capital today based on future earnings.
Introducing Invoice Finance
One of the most popular forms of cash flow lending is Invoice Finance.
This financial solution enables you to access funds tied up in outstanding sales invoices. Instead of waiting for customers to settle their accounts with you, you can submit your invoice (or invoices) to the finance company providing the loan and receive a cash advance of up to 85% of the invoice value upfront. Once your customer pays the invoice, you receive the remaining balance minus any applicable fees.
Since invoice financing is secured by your accounts receivable rather than projected cash flow, your outstanding invoices serve as the sole collateral for the loan. This means you won’t have to leverage personal assets, such as your home, to secure financing, and makes it a more accessible option for many businesses.
For more details on how Invoice Finance works and how you can apply for it with ScotPac, visit here.
How Much Does Cash Flow Financing Cost?
The cost of cash flow finance varies based on the level of risk perceived by funding provider. Factors such as the volume and value of your invoices, the creditworthiness of your customers, and other considerations play a crucial role in determining the overall cost, fees and the percentage of the invoice value that will be provided.
Generally, though this is not a hard and fast rule, financing a higher number of invoices and working with more creditworthy customers can lead to lower costs.
It’s important to note that different cash flow financing options may have varying costs associated with them as well, depending on how they are structured. Understanding these costs is essential for making informed financial decisions for your business.
How Long Does It Take to Secure Cash Flow Finance?
The application process for cash flow finance is much faster than traditional bank loans. If your financial records are up to date, you can expect approval within just a few days and, moreover, once your application is approved, you may receive the working capital in as little as 24 hours.
Is Cash Flow Finance Right for Your Business?
Many growing businesses face working capital challenges. Whether your business is onboarding new customers, experiencing rapid growth or needing to weather macroeconomic or cyclical sales challenges, cash flow finance may be the right solution.
According to research included in our latest SME Growth Index report, 25% of small and medium sized enterprises said that the loss of a major client or supplier would be a catalyst tipping them into insolvency – which reflects significant working capital constraints.
Cash flow financing can be an effective solution for many businesses experiencing disruptive or debilitating cash flow gaps. It is also an excellent option if you require a quick cash injection to cover unexpected expenses or capitalise on time-sensitive opportunities.
So, how can you know if it is right for you?
One of the most effective strategies for identifying and preparing for potential working capital shortages is to create a cash flow forecast. This tool will enable you to anticipate cash inflows and outflows, helping you make informed financial decisions for the overall benefit of your business.
If you need assistance crafting a cash flow forecast, check out our step-by-step guide here.
Cash Flow Lending vs. Asset-Based Lending
How does cash flow lending compare with asset-based lending?
Both financial options provide essential capital to help your business grow and achieve its objectives. A strategic combination of both financing types can offer the long-term affordability and short-term flexibility necessary for sustainable growth.
Evaluating Asset-Based Lending
With asset-based lending, the amount you can borrow is determined by the value of the assets you are willing and have available to use as collateral. Traditional secured loans can be challenging to obtain if you lack such assets to secure against and ensure access to the loan.
In fact, just under 50% of total outstanding small business loans in Australia are secured by residential property. This slight decrease in previous years indicates not just changes and challenges in the economy, but a corresponding growing trend towards alternative forms of collateral in business financing.
To learn more about secured lending, read our blog on Secured Business Lending and discover if it’s the right solution for your business.
Evaluating Cash Flow Lending
In contrast to asset-based lending, cash flow lending allows you to borrow based on your business’s projected cash inflows. Lenders focus less on the value of your physical assets and more on your ability to repay the principal loan amount with interest. This makes cash flow lending particularly advantageous for businesses that may not have significant assets but have strong revenue potential.
As a general rule of thumb, asset-based lending is more suitable for long-term financing needs, while cash flow lending offers greater flexibility for short-term working capital issues.
Pros and Cons of Cash Flow Financing
As with any funding solution, cash flow financing comes with its own set of advantages and disadvantages:
Pro #1 – Quick Access to Funds
Since no asset valuation is required, cash flow lending can provide capital to cover cash flow gaps or seize opportunities significantly faster. With Invoice Finance, for example, you can access funds within 24 hours of submitting an invoice.
Pro #2 – Avoid Long-Term Debt
Instead of accumulating debt on your books, you can free up capital tied up in accounts receivable. Invoice Finance enhances your cash flow without locking you into a lengthy repayment schedule.
Pro #3 – Easier Accessibility
Invoice Finance is generally more accessible than traditional secured loans. Even small businesses with a limited trading history, a poor credit score, or a lack of high-value assets can still qualify for this funding facility.
Pro #4 – No Property Security Required
You won’t need to use your home as collateral. With secured loans that use personal property as collateral, failing to make repayments could mean you, as the business owner, risks losing your property.
Con #1 – Reduced Profit Margins
One significant consideration with cash flow lending is that it may reduce your profit margins. Funding providers typically charge fees based on a percentage of the invoice or invoices’ value, which can impact profitability if you are a business that operates on low margins with high volumes.
Con #2- Credit Limits Tied to Invoice Value
The credit limits for cash flow lending are based on your sales revenue. If you require a substantial amount of funding for a significant expense, Invoice Finance may not cover the total needed. For one-off business purchases, other forms of finance, such as Asset Finance or equipment finance, could be a more appropriate funding option.
Cash Flow Financing with ScotPac
Cash flow financing serves as a vital tool for managing working capital and fostering business growth. This flexible funding solution enables you to unlock the true potential of your business, beyond just the value of your physical assets.
If you think cash flow finance could benefit your business, call us today or fill out the form below to get personalised support from the ScotPac team. We’re here to help you find the right solution to meet your unique business needs.