Cash Flow Financing: A Must-Read Guide for Business Owners

An estimated 99.95% of small business owners seek debt financing to secure the necessary funds for growth opportunities, including opening a new location or bulking up inventory for a busy season.

Within the gamut of business loans, you can find it all. On the one hand, some online lenders offering unsecured loans will approve you very fast but limit the amount of your loan and charge you a very expensive APR.

On the other, traditional banks offer you larger loans (often over $1 million) at a lower APR but take months to fund your account. Cash flow loans strike a balance between loan size, APR, and length of application process.

Cash Flow Financing Basics

Cash flow financing is best suited for companies that can show steady growth of cash inflows and that require an upfront investment to generate more revenue.

The main reason is that a provider of cash flow financing is looking for a business with net income (revenue minus expenses) that can already cover all debt obligations and would be able to handle additional debt with additional cash inflows.

Since a cash flow loan, such as a business term loan, line of credit, or working capital loan, generally requires weekly, bi-weekly, or monthly payments, it is key to to use loan proceeds to finance projects that help your business grows.

Common Use Cases for Cash Flow Financing

Invest in Inventory and Equipment: The inventor of Coco Jack, a Thai coconut opener, had  a strong sales record and then an appearance on Shark Tank drove demand through the roof. Coco Jack had a good problem: it needed to buy inventory and equipment to cover the high demand.

Prepare for Peak Periods: Some small businesses, such as the Tone Academy of Music, are seasonal and require cash upfront to adequately prepare facilities during off-peak periods.

Add a Brick and Mortar Location to an Online Business: Some former digital-only companies, such as Battenwear, are finding that adding a physical location can enhance their brand and overall profitability.

Lock-in a Good Deal: Sometimes you have a very short of window of time for a game-changing opportunity. It may be heavily discounted large batch of raw materials. Or a bright, large office space in Manhattan, as it was for the owner of Gin Lane.

Hire Additional Staff: The founders and co-owners of High Tide, a creative agency, were in need of filling a couple of much-needed roles, including an account manager.

Open a New Location: After successfully opening 10 outposts using a combination of friends and family investment and sales revenue, the owner of Joe Coffee needed additional funding to open his 11th location.

Types of Cash Flow Loans

Here are the five most common types of cash flow financing—and what’s best for whom and when.

Business Credit Cards

In 2014, about 7% of small businesses used business credit card debt to finance projects.

The relative easy access to business credit cards makes this type of cash flow loans one of the preferred ways to cover short term needs.

According to a National Small Business Association (SBA) study, about 37% use credit cards for that purpose.

However, high APRs (ranging from 13.12% to 19.87%, depending on credit score) and low borrowing limits make them impractical to cover large cash flow gaps or capital-intensive projects.

Business Credit Cards Are Best For:

• Covering operational costs that can be typically paid back in full within a month.
• Proper use of a business credit card allows a small business owner to increase her company’s short-term purchasing power.
• For companies with less than one year of operations, a business credit card may be among the few ways to secure debt financing and a useful way to start building a business credit score.

Term Loans

If you have a mortgage, student loan, or car loan, then you’re already familiar with how a term loan works.

You borrow a lump sum upfront and pay it back in fixed weekly, biweekly, or monthly payments throughout the term of the loan.

For example, Funding Circle offers term loans up to $1,000,000 with competitive interest rates, terms from 6 mos. to 5 years, and upfront set monthly payments.

Term Loans Are Best For:

• Established small business owners considering an investment that will generate a steady increased stream of cash inflows as a result of that initial investment.
• Among the advantages of term loans is their fast approval time, ranging from 2 days to 2 weeks. The actual APR of a term loan depends on several factors, including length of the loan, collateral to secure the loan, and the borrower’s credit history.

Credit Lines

In 2014, about 16% of small businesses used credit lines, according to SBA data.

Like a business credit card, a credit line gives you access to cash flow financing that you can tap as you need to cover working capital needs or make investment opportunities.

Unlike business credit cards, credit lines are more formal agreements between financial institutions and borrowers and often require an existing relationship.

One advantage of credit lines is that they tend to charge a lower interest rate than a business credit card.

Credit Lines Are Best For:

• Credit lines are very useful for small business owners that require capital to cover seasonal cash flow gaps on a rolling basis. It would be impractical to apply for a loan every single time you have a cash flow gap, so having access to a predetermined amount as needed saves the company time and money.
• Credit lines can also be useful for making periodic cash payments that vary in size to suppliers, vendors, or contractors that don’t accept credit card payments.

Invoice Financing

Landing a big contract with a government agency or large corporation is awesome news for a small business owner. It also means that he will have to come up with cash upfront to meet short-term needs to fulfil the large order.

Invoice financing is cash flow financing by borrowing money based on amounts due from customers. Providers of this type of financing are often financial institutions or the large corporations or government agencies themselves.

Keep in mind that lenders generally pay out about 70% to 80% of the value of qualifying accounts receivable (often those under 90 days, but requirements vary by lender).

Invoice Financing Is Best For:

• Small businesses that have a long history of making sales on credit and are able to collect the majority of accounts receivable within 60 to 90 days. 
• Businesses that have achieved top-tiers of preferred vendor status with a large corporation or government agency and could qualify for invoice financing with that same organization.

Merchant Cash Advance

A merchant cash advance isn’t a loan; instead, it’s an advance payment against your business’s future income.

The merchant cash advance provider gives you a lump sum, which is then repaid automatically using a percentage of your daily credit card receipts.

Depending on the advance amount, terms may be as short as 90 days or as long as 18 months. Repayment begins immediately after the funds are received.

While there are instances where a merchant cash advance is the right financing option for a business, it is important that you understand the true cost of capital. Unlike a loan, a merchant cash advance isn’t assigned an annual percentage rate. Instead, business owners pay what’s known as a factor rate, which can be confusing.

MCA’s Are Best For:

• Small businesses that lack a strong business credit score, but that are able to demonstrate steady stream of cash inflows through credit card statements or payment processing platforms, such as Square, Paypal, or Shopify.

Cash Flow Financing FAQ’s

How should I compare one form of cash flow financing against another?

The annual percentage rate (APR) is the right benchmark to evaluate all of your debt financing options.

The APR is the annualized cost of a loan, including all interest payments, fees, and services charges.

Here’s an example, let’s imagine that you’re considering two cash flow loans:

• A $80,000 term loan payable in 24 months with a fixed interest rate of 11% and an origination fee of 3%
• A $80,000 cash merchant advance with a payback amount of $90,000, a 15% charge on projected monthly card sales of $60,000, and an origination fee of 3%

The estimated APRs of the term loan and the cash merchant advance are 14.08% and 36.39%, respectively.

The APR of a loan allows you to check whether or not it falls within your acceptable range of cost of debt financing.

Do I really need a business credit score for cash flow financing?

Some forms of cash flow financing, such as business credit cards and merchant cash advances, don’t require your business to have an Employer Identification Number (EIN).

An EIN is the equivalent of a Social Security Number for a business and it allows the IRS and the credit reporting agencies to track the business activity to build a business credit score.

That being said, establishing and maintaining a good business credit score is a best practice for one key reason. Having a business credit score forces you to separate your business and personal finances, which helps you to backup your claims for business deductions on tax returns and protecting your personal assets against creditors.

If I’m turned down by a lender, how long should I wait to apply again?

Generally speaking, the more years that your small business has under its belt, the higher its chance to land cash flow financing.

For example, Funding Circle requires a minimum of 2 years of operation to consider your application. Waiting to meet that requirement can allow you to land a term loan of up to $1 million or refinance an existing higher-interest loan at a lower rate in the future.

Two other benefits of considering a term loan with Funding Circle is that there’s no origination fee to submit your application (only once you accept a loan) and that your application isn’t reported to the credit bureaus.

Unlike other lenders, Funding Circle performs a soft inquiry when reviewing your application, meaning that this routine review won’t affect your credit score. With a bank, credit card issuer, or other type of lender, your credit score will go slightly down due to hard inquiry at the time of your loan application. Every hard inquiry can take up to 5 points off your FICO score and will remain on your credit report for up to 2 years.

Lenders, including credit card providers, report data to the credit reporting agencies once a month. It generally takes 30 to 45 days for your score to be updated. This is why credit underwriters recommend to wait at least 3 months before reapplying for cash flow financing. That way you can evaluate whether or not your efforts to raise your credit score have paid off and you’re ready to apply again.

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