Obtaining a business loan is not always an easy task. A bank will typically approve a loan after certain assets are offered as collateral. Small businesses frequently lack sufficient assets to pledge. This not only creates a difficult situation for small entrepreneurs but also causes well-established businesses to struggle. Businesses frequently require loans for a set period of time in order to meet seasonal demands or purchase requirements. However, the banking system is unresponsive and cannot provide assistance to businesses, even for a short period of time, because no fixed assets are guaranteed.
Cash Flow Financing
What is cash flow financing? It is a way of availing running finance to meet the short-term financial needs of the business through which the business can get a loan from the bank. But this loan is guaranteed by the expected cash flow from future sales rather than the physical or fixed assets of the business. The cash flow of any business is the amount of money coming in and going out of the business in a given period. In the case of a cash flow loan, the positive cash flow generated over a specified period of time is used for loan repayment.
Positive Cash Flow and Debt
If a business generates a positive cash flow, it means that it is providing enough cash from its income to meet its financial obligations. Banks or other lenders check positive cash flows to determine how much and how long they can issue loans. Given the expected positive cash flow, loans can be obtained not only for the short but also for the long term. This is because it may sometimes take more than a year for a business to make an investment so that the expected amount can be achieved in the form of revenue.
Often, businesses can use this source of financing if they need funds to continue their routine operations. However, cash flow loans for businesses can be used to buy another business or fund a large purchase. The loan amount can be obtained as part of the expected positive cash flow in the future. The bank or lenders review the expected future cash flow statement submitted by the applicant business and schedule the loan issuance and its repayment.
Need for Cash Flow Loan?
Any business, big or small, may experience a temporary reduction in cash flow. This can happen for a number of reasons, such as:
- Seasonal changes may reduce cash sales and increase the credit period.
- A business can incur unexpected costs in the event of a loss or economic distress.
- Starting an expensive new project or making a big purchase can also create a cash-flow gap.
- Taking advantage of a particular opportunity in time can also affect temporary cash flow, such as benefiting from buying goods at a higher discount.
- Emergency repairs to essential equipment or machinery may also be required.
There are a number of other reasons why cash flow loans for businesses could be required due to the difficulty in their cash position. But most often, small business cash flow loans are used to fulfill short-term gaps. Banks need to offer temporary support.
Cash Flow Estimate
How to do a statement of cash flow? A document called a cash flow statement is prepared to show the cash flow of any business. This document reports the cash flows generated as a result of all business activities and represents the net income or cash position of any business. The business activities for the purpose of preparing the cash flow statement are divided into three parts.
- Daily tasks are called operating activities. The resulting cash flow of such activities is called operating cash flow. These include supplier bills that are paid by the business and also include operating income from sales (cash and credit sales recoveries).
- Some activities are investing activities. Under them, the investment made by the business in another place or the investment coming into the business itself is calculated.
- The third type is called financing activities. Such as raising funding through loans or providing capital by the owners etc.
The positive or negative cash flow in a business is derived from the accumulation of cash flow from all three types of activities. In order to apply for a cash flow-based loan, it is necessary to review all these expected activities for the future period under review so that the cash flow can be accurately estimated. Banks use the same estimate to determine the size of the loan and repayment schedule.
To estimate how much cash will be generated in the future, the Bank specifically considers receivables of credit sales accounts and payables of credit purchase accounts. The bank also reviews the applicant’s credit history or credit rating to accurately estimate the risk associated with cash flow loans for investors.
Benefits of Cash Flow Loan
A loan based on a guarantee of physical assets is safe for the bank, but it becomes a huge risk for the business. The bank has the right to legally seize the assets in case of default. This can cause a business to lose complete control over its assets and its ability to operate.
On the other hand, even for a bank, exercising complete control over pledged physical assets is not an easy task. Even in the case of default, the bank has to go through significant legal complications to recover the loan by selling the secured assets. In some cases, the market value of assets significantly drops until the point of sale or auction.
With cash flow-based financing, borrowing and lending become easy for both parties. Small business cash flow loans are a solution to financing problems because they do not have many physical assets, as exemplified by today’s service or technology-related businesses. But current or projected sales of these businesses can be quite impressive. Therefore, both lenders and borrowers can significantly increase their own revenue by using the cash flow financing method. If banks are unwilling to be flexible in their policies in this regard, the amount of outstanding loans may be reduced significantly in the future. Because over time, there has been an upward trend in investment in digital or intangible assets rather than physical assets.
The cash flow loan for business allows entrepreneurs to obtain a loan by offering future cash flows as collateral. Most businesses have short-term needs for which such loans can be used. These businesses can be saved from closing due to a failure to meet short-term needs in this manner. It has the potential to be a good and positive solution, particularly for small businesses, the service, and IT sectors, and the cottage industry to thrive.