Cash flow is the movement of money in and out of a business. It’s one of the best indicators of your business performance: if you have positive cash flow, your business has enough cash coming in to cover short-term expenses. Negative cash flow could mean you are spending more money than you are bringing in.
In either case, an influx of working capital can give you the flexibility and support you need to grow your business. Many businesses use cash flow loans, among other funding options, to cover growing demands of running their business day-to-day.
What is a cash flow loan?
Cash flow loans are a category of unsecured financing where lenders use your historical and projected cash flow to help determine your borrowing capacity. These loans are meant to increase working capital to help you cover operational expenses or take on new opportunities to grow your business.
With cash flow loans, businesses can receive large amounts of funding, and don’t typically need collateral or strong credit to qualify.
Since these are not considered traditional bank loans, they are mainly available through online lenders with flexible qualification requirements and higher borrowing costs.
Although lenders may look into your credit, it is not usually the deciding factor. With this type of funding, lenders focus on your ability to generate cash flow, and strong revenue can make up for a lack of credit.
Cash flow loans are some of the fastest ways to receive funding, but also the most expensive. Since cash flow loans have more flexible requirements, they present a greater risk for lenders and come with much higher interest rates than traditional bank loans. Some lenders will even require a blanket lien or personal guarantee, where you have to use your business or personal assets as collateral for your loan.
While cash flow loans may present some risk, they can be a helpful option for businesses in need of short term funding to cover operational expenses or take on a new project.
How do cash flow loans work?
There are multiple types of cash flow loans, along with many different lenders, so the specifics here vary.
For most cash flow loans, you borrow capital and agree to repay the lender with a portion of your future revenue. The average APR for cash flow loans can range anywhere from 10% to 90% depending on the provider, the loan, and the repayment schedule you choose.
Additionally, repayment terms can range anywhere from 3-36 months and some lenders may charge high fees or significant late penalties.
To repay these loans, lenders take daily or weekly payments directly from your bank account or credit card sales revenue. These are usually automatic payments and can drain your finances if sales decline unexpectedly.
Since these loans are a short term funding solution with high borrowing costs, they work best for growth opportunities rather than keeping your business afloat.
You can use cash flow loans to:
- Increase inventory
- Purchase bulk inventory at a discount
- Stock up for high traffic seasons
- Secure materials for large projects
- Upgrade your equipment
- Fix or replace the equipment you need to run your business
- Make it through slow seasons
- Keep business running when sales are down but expected to return
- Take on new opportunities
- Say yes to a new client or project and cover the costs needed to get the job done
- Cover gaps in cash flow
- If you have outstanding invoices, a cash flow loan can help cover expenses while you wait for customers to make payments
The differences between cash flow loans and asset-based loans
Cash flow loans are unsecured and don’t require collateral. While these loans are easy to qualify for, they may present more risk and higher borrowing costs compared to more traditional loan options.
Asset-based loans, on the other hand, are secured by some sort of collateral and tend to have low rates. Both secured and unsecured loans have their benefits, and risks, but it’s up to you to decide which option works best with your funding goals, personal credit, and available assets.
Asset based loans require collateral such as real estate, equipment, or inventory owned by your company. While cash flow loans don't require collateral, they are still secured based on your projected cash flow, credit score, and sometimes a personal guarantee or blanket lien.
Asset based loans can take at least a month for lenders to even review your application. Your lender will then spend time evaluating your business and may require an in-person visit to examine the assets you plan to use as collateral. On the other hand, you can receive funds from a cash flow loan in as little as 24 hours depending on the specific loan and lender you choose.
For asset based loans, you'll make monthly or weekly repayments that will depend on various factors of your loan. For cash flow loans, you'll make automatic daily or weekly repayments taken directly from your bank account or credit/debit card sales.
The different types of cash flow loan
A cash flow loan is an umbrella term for the various funding solutions that allow you to leverage your past and future sales revenue to help secure additional capital. These funding solutions each have slightly different qualification requirements, repayment structures, and borrowing costs.
A business line of credit
What it is
A business line of credit is a financing option where you borrow money from a lender, up to a pre-approved credit limit. You can receive funds and make repayments as long as you’re within your limit, and you only pay interest on the capital you actually use. The APR for a line of credit can range anywhere from 3% to 80% and lenders may let you borrow up to $500,000 depending on your qualifications.
A business line of credit is helpful for businesses looking to cover operational expenses with the help of short term funding they can use as they need. You can use a business line of credit to prepare for emergency expenses or secure short term funding to support an ongoing project.
A business line of credit lets you borrow a larger amount of capital, with lower rates, compared to business credit cards and other short term options.
Additionally, you can gain access to revolving funding you can use as you need.
Lenders usually have minimum draw requirements, high credit requirements, and some even require a personal guarantee.
Merchant cash advance
What it is
A merchant cash advance, or MCA, is an alternative financing option to the traditional small business loan. A lender gives your business a sum of money, and you repay it with a percentage of future sales revenue. With MCAs, you receive quick access to capital, but they can be risky and expensive.
It’s important to note that a merchant cash advance is not considered a loan. MCAs are considered commercial transactions where a provider purchases a percentage of your future sales. Cash advances operate differently than more traditional financing options like loans, and it's up to you to determine if a MCA is the best choice for your business and financial goals.
MCAs have a simple application process, and you can receive your advance in as little as 24 hours to a week depending on the lender. You don’t need a lot of paperwork to get started and repayment is often the longest part of the process.
MCAs are also unsecured, meaning you don’t have to put your business assets at risk in order to qualify. This is why MCAs are a popular option for business owners who haven’t had a chance to build good personal credit or even a business credit profile.
When your sales decline or stop altogether, so do your repayments!
Unfortunately, the APR for a merchant cash advance can range anywhere from 20% to as high as 250%. This is much more expensive than the typical small business loan, which tends to have an APR of 10% or lower.
Merchant cash advances don’t help you build credit, but if too many lenders pull your score it could have a lasting impact on your credit profile.
Business term loan
What it is
With term loans, you borrow capital from a lender, and agree to pay it back with fixed repayments. These loans have the lowest interest rates but also have strict credit or business performance requirements, and don’t typically accept start-ups.
You can find term loans from banks and credit unions, but online lenders will likely charge a higher interest rate. Term loans work best for established businesses who have a plan in mind for how to leverage new capital.
Term loans have generally low rates and a predictable repayment schedule. The average APR for a term loan ranges from 7% to over 30% depending on your loan provider.
Most lenders don’t have strict requirements on how to use your capital and allow you to borrow a large amount at once.
When you apply for a term loan, it can take a while for the lender to review your application and send the funds you need. Additionally, these loans have a long- term repayment schedule compared to other cash flow loan options.
To qualify for a term loan, you’ll need strong credit and a significant business history or you will end up paying more in borrowing costs.
Short term loans
What it is
Short term loans operate like business term loans, but with a much shorter repayment period. With this type of loan, you make daily or weekly repayments within a typical repayment period of 18 months or less. This is a financing option for businesses who need capital fast and don’t want a long term repayment structure.
These loans are much easier to qualify for than business term loans. Lenders have more flexible qualifications which result in a quicker application process.
Since these loans are meant to be short term, you receive funding fast and make repayments over a few months
Short term loans allow you to borrow smaller amounts of capital than business term loans.
Since lenders have more flexible requirements, they charge higher fees for the increased risk that they take on.
How to qualify for a cash flow loan
Qualification requirements can vary for each type of cash flow loan option. Although these loans are easier to qualify for than traditional bank loans, lenders still need you to prove you can generate incoming cash flow and stay on top of repayments.
To determine if you qualify, lenders may look at your debt to income ratio, projected revenue growth and operating cash flow. Lenders will use your debt to income ratio or DTI to help understand any existing financing you may have.
This ratio helps determine your ability to take on additional debt, and if so how much. The lower your DTI, the more likely you are to qualify for the loan of your choice.
Lenders use your projected revenue growth, past performance and intended use for the funds to further anticipate how much capital you qualify for. This process is more complicated for seasonal businesses and may require additional insight into your finances.
Finally, operating cash flow, or net cash from operating activities, is a formula used to calculate how much money you generate. When you have strong operating cash flow, you’ll qualify for better loan options and end up paying less in borrowing costs.
Overall, cash flow loan requirements are based mostly on the borrower's ability to generate cash flow both in the past and moving forward. This can be a helpful option for start ups without collateral, an extensive business history or credit profile.
As with any type of financing, cash flow loans are meant to help businesses secure the working capital needed to grow. The specifics of each loan option vary, and you should evaluate your personal and business finances to help determine the best option for you. If you're in need of fast,short-term funding, and don't qualify for traditional loan options, a cash flow loan could be the best option for you.