How to Understand Cash Flow Loans

ByG. Dautovic
April 13, 2022

When cash flow loans first became available, banks were the only ones who could offer them. In recent years, however, cash flow loan companies have sprung up to meet the needs of small business owners.

These companies offer cash flow loans on a more flexible basis than banks, and they’re willing to work with businesses that don’t have perfect credit.

So if you’re looking for cash now and don’t want to deal with the hassles of a bank or credit union cash advance program (such as waiting in line or filling out mountains of paperwork), cash-flow loans may be the right solution for you.

Still, there are some potential downsides and risks to cash-flow loans you should be aware of before taking one out.

What Is a Cash Flow Loan?

A cash flow loan is a short-term loan used to cover your business’s expenses until you receive payment for goods or services you’ve already delivered.

For example, if you need to purchase inventory but know you won’t receive payment from your customers until 30 days after the sale, a cash flow loan can be used to cover the cost of the inventory until the payment from your customer arrives.

In other words, it’s a way to tide your business over when cash is tight.

Cash flow loans are a type of unsecured loans (they’re not backed by any collateral) and are used to fund day-to-day operations of your small business, such as inventory, payments for payroll, rent, accounts receivable, and other short-term expenses. This implies you’ll be borrowing against anticipated future revenues.

How Cash Flow Loans Work

Cash flow loans are typically offered by cash-flow loan companies, not banks.

The application process is usually much simpler than that of a bank loan, and you can often get your money in as little as 24 hours.

Cash flow lending is designed to help small businesses that have trouble qualifying for traditional bank loans. The loans are based on your business’s cash flow, not your credit score or credit history.

This means that even if you have bad credit, you may still be able to qualify for a cash flow loan.

The lender will review your business’s cash flow and make a decision based on that. If approved, you’ll get the cash you need deposited into your bank account within days.

How To Qualify for a Cash Flow Loan

To qualify for a cash flow loan, a small business owner must have a positive cash flow. This means you must have consistent revenue coming in - a minimum of $15,000 each month - and it must be enough to cover your expenses.

Your small business must also be in operation for at least six months. 

Because no collateral is given, the lender’s primary concern is the quality of your accounts receivables, accounts payables, and inventory turnover.

To assess how you manage your company’s cash flow, lenders will focus on your current and future revenue. 

To determine your current revenue, the lender will examine your bank statements and financial records. They’ll also look at your projected revenue for the upcoming months and consider your business’s overall financial health and your history of making timely loan payments.

They’ll also want to see if you have a good handle on your inventory, meaning that you don’t have too much or too little. If you have a strong track record of success, you’re more likely to be approved for a cash flow loan.

Pros of Cash Flow Loans

There are several advantages to cash flow loans:

  • You can get your money quickly. The application process is usually much simpler than that of a bank loan, and you can often get your money into your bank account in as little as 24 hours.
  • The loans are based on your business’s cash flow, not your credit score. This means that even if you have bad credit, you may still be able to qualify for a cash-flow loan.
  • This type of loan can tide your small business over when cash is tight. Cash flow loans will provide you with the funds needed to cover your working capital expenses until you receive payment from customers. 
  • They help you improve your business’s cash flow. By taking out a cash flow loan, you can free up cash that was tied up in receivables and use it to pay other expenses.

Cons of Cash Flow Loans

Despite all the benefits we’ve mentioned, cash flow loans are not ideal for every situation. Before deciding to apply for this type of financing, consider the following downsides:

  • You may have to pay multiple fees. Some cash flow lenders charge application and origination fees. These fees can add up, so be sure to compare the total cost of the loan from various lenders before you decide on one. 
  • The interest rates can be high. Cash flow loans typically have higher interest rates than bank loans, especially if you’re applying with alternative or online lenders.
  • You may have to put up collateral. Most cash flow loans are unsecured. However, some cash-flow loan companies require you to put up collateral, such as your business’s equipment or inventory. Some may ask for a personal guarantee to be included in the debt agreement. In this case, your personal assets will be used as collateral.
  • Cash flow loans are short-term. This means you’ll need to repay the loan, plus interest and fees, within a few months.
  • There’s always the risk that you won’t be able to repay the loan. As with any other type of loan, there’s a chance you won’t be able to offset the debt. If you can’t repay your cash flow loan, you may have to put up collateral or hand over equity in your business.
  • Lack of transparency. Some cash flow companies are not very transparent about their fees and terms. Be sure to read the fine print before you sign any loan agreement.
  • You could damage your business’s cash flow. If you’re not careful, cash flow loans can actually damage your business’s cash flow. Taking out this type of loan can put you in a cycle of debt, where you’re constantly taking out new loans to repay old ones.

When To Use Cash Flow Loans

Cash flow loans can be a good option for businesses that experience sporadic spikes in demand. They can also be helpful if you have a short credit history or bad credit and are having trouble qualifying for a bank loan with one of the traditional lenders.

However, cash flow loans should be used with caution. Compare the costs and terms of several lenders before you decide on one, and make sure you can afford the repayments. Even better, make a repayment plan before you sign the loan agreement.

Alternatives to Cash Flow Loans

If you’re not sure a cash flow loan is right for your small business, there are other financing options to consider.

  • Bank loans: Bank loans tend to have lower interest rates than cash flow loans. However, they can be difficult to qualify for if you have bad credit.
  • Business credit cards: Business credit cards often offer introductory 0% APR periods. This can be helpful if you need to make a large purchase and want to spread out the payments interest-free.
  • Invoice factoring: With invoice factoring, you sell your invoices to a factoring company at a discount. The company then pays you the cash upfront and collects payment from your customer.
  • Merchant cash advances: With a merchant cash advance, you receive a lump sum of cash in exchange for a percentage of your future credit card sales.
  • SBA loans: SBA loans are government-backed loans that typically have low interest rates and long repayment terms. However, they can be difficult to qualify for.
  • Term loans: Term loans are a type of bank loan that typically have lower interest rates than cash flow loans. They also have longer repayment terms, which can make them easier to afford.

Cash Advances as Cash Flow Loans

If your business has a high credit score, you may be able to qualify for a cash advance.

A cash advance is a type of cash flow loan. With a cash advance, you can borrow money against your business’s future sales.

The amount of money you can borrow with a cash advance depends on your business’s credit score and monthly sales. If you have a stellar credit score, you may be able to qualify for a cash advance of up to 100% of your business’s monthly sales.

To qualify for a cash advance, you’ll need to provide the cash advance company with your business’s bank statements and credit card processing statements. The cash advance company will use these statements to verify your business’s sales.

If you have strong personal credit, you may be able to qualify for a cash advance even if your small business has a low credit score.

In Conclusion

Whether a cash flow loan is an optimum solution for your small business will depend on a number of factors. Before making a decision, consider how fast you need those funds, the loan amount required to tide your business over, and your credit score.

It’s also important to realistically assess your future cash flow and whether you can expect your clients to pay for the services rendered in time for you to repay your loan.

And finally, don’t assume all lenders are the same. Instead, review offers from multiple lenders to find the one with the best terms.

FAQ

What is a cash flow loan?

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A cash flow loan is a type of financing that allows you to quickly borrow money against your business’s future sales. This type of loan is typically used to bridge the gap between incoming and outgoing cash, allowing businesses to cover expenses during periods of low cash flow. Because cash flow loans are based on future revenue, they can be easier to obtain than traditional loans. Understanding cash flow loans can help you get a loan for your business faster and without putting your capital assets at risk.

How long do you have to repay a cash flow loan?

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Most cash flow loans are short-term loans, which means you’ll need to repay the loan, plus interest and fees, within a few months.

Do you need collateral for a cash flow loan?

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Usually, you don’t, although some cash flow lenders do require you to put up collateral, such as your business’s equipment or inventory.

What is cash flow financing?

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Cash flow financing is a type of financing that allows you to borrow money against your business’s future sales.

How do you know if a loan is legit?

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First, make sure that the lender is licensed and accredited. You can check with your state’s banking department to see if the lender is registered. Second, look for professional and customer reviews of the lender online. Finally, check the Better Business Bureau website to see the lender’s rating.

Is cash flow loan interest tax-deductible?

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Yes, cash flow loan interest is tax-deductible.

About author

I have always thought of myself as a writer, but I began my career as a data operator with a large fintech firm. This position proved invaluable for learning how banks and other financial institutions operate. Daily correspondence with banking experts gave me insight into the systems and policies that power the economy. When I got the chance to translate my experience into words, I gladly joined the smart, enthusiastic Fortunly team.

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