Understanding Cash Flow Based Lending

Whether a company is just getting started or an established corporation, it relies on borrowed capital to run its operations. Business entities are presented with a wider array of financing options as compared to individuals which can make business borrowing much more complex. If you are looking for suitable financing for your business operations, find out more about cash flow based lending and how it can support your company.

Cash Flow Lending

Cash flow lending enables businesses to borrow money based on their projected future cash flows. This financing option involves a loan that is granted by the lender and is backed by the borrower’s past and future cash flows. By definition, cash flow lending is when a business borrows money from its projected revenues which they anticipate on receiving in the future. This type of lending also reviews the borrower’s credit ratings to determine their creditworthiness.

For instance, a company that intends to sustain its payroll obligations can utilize cash flow lending to pay its staff and repay the loan along with its interests on the generated revenues on a future date. No collaterals are needed on this type of financing but a portion of the cash flows are usually secured.

Cash Flow Underwriting

The underwriting of cash flow loans involves lenders examining future company incomes, its enterprise value, and its credit rating. This option is favored by companies as it is much faster to process without the need for any collaterals. Cash flow based loans are often underwritten by financial institutions through the use of a company’s earnings before taxes, interest, amortization, and depreciation, along with a credit multiplier.

Cash flow based lending lets lenders account for any risk brought on by economic and sector cycles. As many companies will see a decline in their company’s earnings before taxes, interest, amortization, and depreciation during an economic downturn, the risk multiplier used by the financial institution will simultaneously reduce. These two declining numbers combine to lower the available credit capacity for a company or increase interest rates if it has been stated as part of the criteria.

Cash Flow Suitability

Cash flow loans are more suitable for businesses that can keep high margins or are lacking enough hard assets that can be put up as collaterals. Business that meet these qualities can include marketing firms, service companies, and producers of low-margin products. These loans typically charge interest rates  that are relatively much higher as compared to other alternatives as they compensate for the non-requirement of a collateral which can easily be obtained by the lending institution in case of a payment default.

Business Loans Options

As businesses have a wider variety of loan options, you can carefully look through the pool of financing choices you have to ensure you pick the one that best meets your business needs. Whether you are running a startup or a mega organization, the key is to borrow something that is within your financial means. This will enable you to maintain steady payments month after month so as to sustain business growth.