Cash flow refers to the total amount of money going in and out of a business over a period of time and serves as a key indicator of the business’s financial standing. Having a healthy cash flow is not only crucial for your business to operate, but it can also provide insight for making financial decisions.
Whether you’re just starting your business or looking to expand, you may find you need more working capital and therefore must increase your cash flow. If you’ve already reduced your business expenses but still need the funds to efficiently run your business, you may opt to take out a cash flow loan.
If you’re considering this option, it’s important to understand how a cash flow loan works and the typical qualification requirements to determine if it’s right for your business.
- A cash flow loan is a business loan used to cover operating expenses and ultimately improve cash flow.
- Cash flow loans are unsecured, and collateral is typically not required. Instead, the business’s revenue and cash flow projections are used to back up the loan.
- While cash flow loans can be acquired by businesses with bad or little credit (or no credit or collateral at all), they come with higher interest rates and may require a personal guarantee.
- The application process for cash flow loans can vary depending on the lender. Some may need considerable documentation, while others may rely more on your credit score.
What Is a Cash Flow Loan?
A cash flow loan is a type of business loan used to improve the cash flow of a business so that it can cover its expenses. This type of loan usually covers operating expenses required to run the business (such as rent or office space), utilities, equipment, supplies, and inventory.
Cash flow loans are unsecured, meaning property or assets are not necessarily required as collateral to “secure” the loan. Instead, the loan is approved based on cash flow projections or the revenue the business expects to make.
How Does a Cash Flow Loan Work?
Like many other business loans, cash flow loans are generally approved for a specified amount and paid off in installments within a certain period. Generally, the lender takes the payments of the loans directly from the business’s account and a higher interest rate is applied since these loans are unsecured.
Cash flow loans work similarly to working capital loans, as the funds are used to cover daily operational expenses. However, instead of using collateral, the cash flow loan is dependent on the business’s actual revenue, and lenders refer to a business’s past and future cash flow projections to decide whether to approve them.
The cash flow projection statement gives lenders insight into the expected revenue, as it shows the incoming and outgoing cash the business expects within the year.
Pros and Cons of Cash Flow Loans
Businesses with bad credit, little credit, or no credit can be approved
Doesn't require collateral
Personal and business assets are not at risk
Must be in business for a certain amount of time
Businesses must prove efficient cash flow or projected revenue
Interest rates are generally higher since no collateral is offered
Personal guarantee may be required
There are several benefits of a cash flow loan, which can help businesses that may be struggling in certain areas.
For example, businesses with bad credit that are unable to secure a traditional loan can qualify for cash flow loans because the focus is on its revenue, not its credit history. Businesses that have good credit but don’t have collateral—and business owners who don’t want their personal assets at risk—also benefit as the business’s revenue serves as the way to back up the loan instead of collateral.
There are some drawbacks of cash flow loans, depending on your business’s overall standing. For instance, a business is usually required to be open and operational for a certain amount of time (such as one to two years). This proves the history of a business’s cash flow and gives a more accurate representation of projected revenue.
Since collateral is not required, lenders rely heavily on the information based on the business’s cash flow projection to make a decision. This lack of collateral also results in higher interest rates than those of secured loans. Along with the higher rates, lenders may also require a personal guarantee to lower their risk. This means that if your business cannot pay back a cash flow loan, you as a business owner will be personally responsible to do so.
When Is a Cash Flow Loan Right for My Business?
Cash flow loans can be a good solution for businesses such as retailers that hit seasonal peaks and need to buy inventory to address a spike in demand. Startups might also consider cash flow loans when trying to expand or develop a new product.
If your business has bad credit or not enough credit history, you might consider a cash flow loan, as the credit score is not a major factor in the application process. These loans may also be beneficial for those who don’t have collateral or don’t prefer to use collateral for a loan since revenue is used instead.
How To Get a Cash Flow Loan
Cash flow loans can be easier to obtain when a business shows a healthy cash flow projection. If you decide to move forward, here are some key steps you should take:
- Conduct research to compare lenders and consider your options.
- Review your credit score to know where your business ranks, since this is a general requirement of loan applications and could have an impact on the interest rate.
- Gather any necessary documents required by the lender, such as bank statements, cash flow projections, and other financial statements.
- Review your cash flow projections and expected revenue amounts for accuracy.
- Submit your application as directed by the lender, with all required documents and information.
The application process for cash flow loans can vary depending on the lender. Some may require more documentation, while others may rely more on credit scores. Contact your lender to understand what is required.
Frequently Asked Questions (FAQs)
What are typical interest rates for cash flow loans?
Interest rates vary depending on the lender and the general financial standing of your business, but they can range anywhere from 8% to well over 35%. Cash flow loan interest rates are typically higher than traditional loans since cash flow loans are unsecured.
Where do loans go on your cash flow statement?
On your cash flow statement, any loan activity would be recorded in the “Cash Flow From Financing Activities” section. The funds received from the cash flow loan would be recorded as the incoming cash, while payments and interest for the loan would be recorded as outgoing since this is a business expense.