Businesses across the world run on the same principle of having some idle cash to cover daily expenses. Hence, it becomes imperative sometimes for SMEs to take business cash flow loans. After all, it is often said that cash is the lifeblood of any business and more so when you are in a cash crunch situation when there is an inconsistent flow of cash or while dealing with late payments.
The worst part is, depending on your credit history, certain types of traditional bank loans may not help you get adequate finance. This is where cash flow lending comes into the picture. Do you wish to learn more about this concept and how it is growing in Australia? If yes, keep reading this piece of content wherein the following paragraphs we have discussed its definition along with an explanation of the difference between asset-based lending v/s. cash flow lending.
It is a type of unsecured loan that is utilized by businesses for the smooth functioning of their everyday operations. Generally, this type of loan is employed to finance working capital, including payments for rent, inventory, payroll, etc. It can be paid back in the form of incoming cash flows of your business. In simple terms, it means that you will be borrowing from profits that you are expecting to receive in the future.
When you are looking for this type of finance option for your business, you need to keep this in mind that these loans are not your typical traditional bank loans, which require a more comprehensive analysis of your business’s financial situation, like credit history. Instead of that, the eligibility for lending is decided almost exclusively based on your business’s capacity to generate cash flows.
How Does it Work?
These types of loans are typically utilized by SMEs that do not have the requisite assets to pay back the loan amount. Nor do they have a proven track record of profitability or good credit history. So, it is evident for the lender to charge higher interest rates, and the origination fees are also deemed to be higher. The most important thing is to repay the cash flow loans as soon as possible. The reason being, it can have a draining effect on your business’s finances in case you start missing payments.
Let’s now imagine a situation where this type of lending can be most fruitful. Suppose you have a seasonal business like a greeting card company that typically makes its annual sales in the period between November to January. The company may experience low cash flows during the summer months, which would accumulate the cost of payroll and rent. This is when they might consider opting for this type of loan. As soon as the cash flow picks up again in winter, they will repay the loan with interest.
Loopholes of This Type of Loan for SMEs
As we have discussed in the sections above, cash flow loans can be a type of quick capital injection that can act as a blessing in disguise for SME businesses that are in dire straits. However, like every other thing, even these types of loans have certain loopholes. Let’s look at them.
Apart from high-interest rates, these types of loans typically have high fees on top of significant penalties for late payments. Hence, before you decide on taking this type of loan for your SME business, it is essential to contemplate whether you can deal with these fees in case you miss out on any scheduled payments.
While you do not have to use assets as collateral for this type of loan, lenders may ask you to put in a general lien over your entire business as a part of the loan agreement. In simple words, it means that your business may act as collateral. On top of this, you may be asked to give a personal guarantee for the loan, which will make you personally liable for paying it back.
Certain lenders need automatic payments as a loan condition. For businesses who have fluctuating cash flow every month may find it challenging to maintain automatic payments as you will not have enough money in your bank account to make the payment.
Now that you have looked carefully at all the factors affecting this form of lending, it is time to divert our attention to the difference between asset-based lending and cash flow lending.
Asset-Based Lending v/s. Cash Flow Lending
There are a couple of differences between the two types of lending. The first one is the difference in collateral. Asset-based lending is totally contingent on assets like real estate, equipment, or inventory. On the other hand, cash flow lending for business is based on the expected future cash flows. Even though cash flow is considered by the lender when providing an asset-based loan, it is a secondary consideration to the assets valued on the balance sheet of the company.
The other criteria are the suitability aspect. In the case of asset-based loans, they are most appropriate for organizations having large balance sheets. Lenders typically avoid giving out loans for companies in industries that do not have sufficient cash flow potential. Whereas, cash flow loans are appropriate for those companies that have high margins on their balance sheet along with SME businesses that do not have hard assets to pay off an asset-based loan.
If you are looking for SME business lending to grow your business, take help from Marketlend, a premier platform providing peer to peer lending in Australia.