Opinions expressed by Contractor the contributors are theirs.
What is cash flow financing? With cash flow financing, a business gets a loan, but that loan is backed by the expected cash flow of the business. A business’s cash flow is the amount of money that flows to and from a business, over a period of time. Cash flow financing, or cash loan, uses the generated cash flow to repay the loan.
If a business generates positive cash flow, it means that it is getting enough cash from its income to meet its financial obligations. Banks and credit providers check positive cash flow to determine how much credit they want to extend.
The idea is that companies borrow on a fraction of the future cash flow they hope to generate. Banks or creditors establish a payment schedule. They base this schedule on forecasts of future cash flows and analysis of historical cash flows.
Related: Tips for Managing Cash Flow Funding
Why seek treasury financing?
A business may have a temporary decrease in its cash flow. It could come from less than stellar seasonal sales. A business can be faced with unforeseen expenses. Starting an expensive new project could create a cash flow gap.
Decreased cash flow can also come from a time-limited opportunity, like purchasing equipment at a great price. Or, businesses can experience cash flow crashes when they need to make emergency repairs to vital equipment.
Related: Positive Cash Flow and Smart Financing Solutions
Cash flow statements
All cash flows are reported on what is called a company’s cash flow statement, or CFS. This statement records the income or net profit of a business, for the period covered by the statement. The report calculates the operating cash flow from the expenses related to the management of the business. These include supplier invoices paid by the company. It also includes the operating result from sales. The statement also records all investment activities.
Investing activities include investing in securities or in the business itself, such as the purchase of equipment. The statement records all fundraising activities, such as raising capital through loans or even issuing a bond. The bottom of the cash flow statement shows the net amount of cash generated or lost for the period.
Cash flow projections
Two critical areas in any cash flow projection will be a business’ debts and receivables. A bank must take account of accounts payable. These are short-term debt obligations, such as money owed to suppliers. The bank can use cash net of debts and receivables to forecast cash flow. Banks use this amount to determine the loan amount.
The bank will also have to take account of accounts receivable. Accounts receivable serve as future incoming cash flows for the goods and services that a business sells today. Banks or credit providers will use the anticipated amounts of receivables to help determine how much money will be generated in the future.
Banks may require a minimum credit rating for a company’s outstanding debt in the form of bonds. The companies issuing bonds are assigned credit ratings. This is how the level of risk associated with investing in corporate bonds is weighed.
Cash loans versus asset-backed loans
Asset-based financing helps businesses borrow money. However, an asset on the balance sheet serves as collateral for the loan. The bank places a lien on all assets used as collateral. Assets used as collateral can include inventory, machinery, real estate, company vehicles, etc.
If the business ends up defaulting on an asset-backed loan, the bank lien allows the lender to legally seize the assets. As a result, a business can lose its ability to function.
With cash flow financing, the cash generated is used as collateral for the loan. Collateral does not come in the form of physical or fixed assets. Typical businesses that use cash flow financing often don’t have a lot of assets, like service companies. See: investopedia.com/terms/c/cash-flow-financing.asp.
Cash loans strike a balance between the loan amount, the APR and the length of the application process. Compare this with many online unsecured loans, which can have very quick approval but a limit on the loan amount. In addition, they tend to charge a very expensive APR.
Cash flow financing can also be an improvement over traditional financing. Traditional banks offer larger loans, often over $ 1 million, and lower APRs, but funding an account can take months.
Often times, a business must have been in business for a few years. The borrower may have to meet a certain minimum credit score requirement. They must also prove cash flow history and present accounts receivable and payable, so that the lender can determine the amount to be made available.
Take away food
Cash flow financing allows entrepreneurs to borrow against future cash flows. It is generally used for temporary needs, such as the quick purchase of equipment or the start of a new project. This can be a good solution for service industries with few traditional guarantees.
Related: Outsmart Cash Flow Problems With The Right Financial Solution