What Is a Cash Flow Loan?
A cash flow loan is a type of unsecured borrowing that is used for day-to-day operations of a small business. The loan is used to finance working capital—payments for inventory, payroll, rent, etc.—and is paid back with incoming cash flows of the business.
Cash flow loans are not considered conventional bank loans, which entail a more thorough credit analysis of a business. Instead, a lender makes an assessment of the cash flow generation capacity of the borrower when determining the terms of a cash flow loan.
How a Cash Flow Loan Works
Cash flow loans are typically sought by small companies that do not have a long credit history, significant assets to back a loan, or an established track record of profitability. Because of these factors, a lender will command higher interest rates on a cash flow loan to compensate it for greater repayment risk, although in some cases a blanket lien or personal guarantees by the signer(s) of the loan will be required as part of the debt agreement.
In addition, the origination fee of a cash flow loan is higher than that of a traditional loan and is further subject to greater fees on late payments. However necessary it may be to take out a cash flow loan, in the case of a small business that lacks financing options, it should be repaid as quickly as possible, as it represents a drain on the finances of the business.
A cash flow loan can help a small business finance day-to-day operations in the short term but should be repaid quickly.
Example of a Cash Flow Loan
A corner bakery is seeking $10,000 to purchase ingredients for bread, pastries, and cookies, as well as paper packaging and boxes. With only an oven and a few furniture fixtures, the small business does not have enough assets to obtain an asset-based loan from the bank down the street. It turns to an online lender for a cash flow loan to finance the raw material inventory. As the bakery turns its products into cash over the next several weeks, it repays the $10,000 loan with interest.