Cash Flow Finance In Business, Explained

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Cash flow financing is a type of funding that involves lending money to a business based on its expected cash flows, instead of assets or property as collateral. In other words, it is a form of financing where the lender evaluates the business’s cash flow to determine its ability to repay the loan.

CF (Cash Flow) financing differs from traditional lending, where the lender evaluates the borrower’s creditworthiness, assets, and liabilities to determine the lending risk. In cash flow finance, the lender focuses on the cash flow generated by the business, making it a useful financing option for businesses with limited collateral or poor credit scores.

This type of funding is beneficial for businesses with limited assets but strong cash flow projections. Lenders evaluate a business's past financial performance and projected cash flows to determine its eligibility for cash flow funding.

In this article, we talk more about what is cash flow finance, examples of cash flow financing activities, cash flow from financial activities, and costs associated with it. Let’s go!

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What is corporate cash flow in business?

Before diving into cash flow finance, it’s important to have a clear understanding of cash flow and its activities. Cash flow refers to the movement of cash and cash equivalents into and out of a company. This includes cash generated from operating activities, investing activities, and financing activities.

An analysis of this cash flow can assist businesses in identifying areas where they can improve their cash flow management, such as reducing expenses or increasing customer repayments.

What are the 3 types of cash flows? Operating, investing and financing CFs

The three different kinds of cash flows are cash flow from operating, investing, and financing cash flows. These represent the cash produced or used during regular business operations, asset investments, and financing activities, respectively.

Watch our video on cash flow management to learn more:

What is cash outflow?

Cash outflow describes the flow of cash or cash equivalents out of a business, such as payments made to vendors, staff, lenders, and other expenses.

What is cash inflow?

Cash inflow describes the flow of cash or cash equivalents into a business, such as sales revenue, investment proceeds, and net income from loans or other financing activities.

Now that you have got a good understanding of cash flow, let’s dive into cash flow finance, and its examples.

Cash flow finance — Definition

A cash flow statement is a type of financial statement that depicts the flow of cash and cash equivalents into and out of a company over a given period. It enables companies to keep track of their liquidity and comprehend their capacity to produce cash to finance their operations and investments.

On the other hand, in cash flow financing, lenders accept the borrower’s expected cash flows as collateral instead of tangible assets. It is beneficial for businesses that generate massive cash but lack physical assets, such as equipment, which could serve as collateral for a traditional loan.

Banks or creditors create the payment schedule for cash flow loans based on the company’s estimated future cash flows and an analysis of its historical cash flows. An example of cash flow financing is a business obtaining a line of credit or loan from a bank based on their projected future cash flows.

Banks and creditors evaluate a company’s positive cash flow to determine the credit limit they should extend to the company. When a company generates positive cash flow, it indicates it generates enough cash from its revenue to fulfil its financial obligations. Negative cash flow, on the other hand, indicates that a business is not making enough money to pay its debts and may need to turn to outside sources of funding to stay afloat.

Cash flow financing can be useful for businesses looking to finance their operations or make significant purchases, such as acquiring another company.

What is an example of cash flow loans?

Cash flow financing refers to different types of financing options available to businesses that require short-term funding to address cash flow shortages. The following are some examples of how businesses can finance themselves:

  • Unsecured business loans: Since there is no collateral backing these loans, the borrower is not required to put up any assets as security. These loans are typically for a brief period and are based on the past and anticipated cash flow of the company.

  • Merchant cash advance: A merchant cash advance gives a business a cash advance based on its anticipated future revenue. This financing method is usually unsecured and comes with high interest.

  • Revolving credit facility: Revolving credit facilities are a kind of loan that gives a company access to a credit line that can be used as needed. Moreover, only the amount of credit used is charged with interest.

  • Invoice finance: Invoice finance allows companies to borrow money against outstanding invoices. Based on the value of the outstanding invoices, the lender makes a cash advance, which the business repays once its customers clear the outstanding balance.

Since every business is unique, there's no one-size-fits-all solution to cash flow problems. Depending on the nature of the problem, a business may need to consider various financing options, such as short-term loans (current liabilities) or invoice financing.

For instance, a business facing an unexpected expense may require a short-term loan, while a seasonal business may benefit more from invoice financing to prepare for future cash flow issues. Therefore, choosing the right financing option requires careful consideration of the specific needs of the business.

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Cash flow financing activities — Example

Similar to operating and investing activities, cash flow financing activities are listed on a company’s cash flow statement, which provides a detailed overview of a business’s cash inflows and outflows over a specific period.

Here are some common examples of cash flow financing activities:

  • Issuing shares: A company can raise cash by issuing new sharesto investors.

  • Taking out loans: A business can borrow money from financial institutionsor other lenders to fund its operations or investment plans.

  • Repaying loans: Repaying principal and interest on outstanding loansis also a cash-flow financing activity.

  • Dividend payments: A company can distribute cash to its shareholders through dividends.

  • Buying back shares: A company may choose to repurchase some of its shares from shareholders, resulting in a cash outflow.

  • Refinancing: A business may refinance its existing debt to take advantage of lower interest rates or more favourable repayment terms.

  • Lease payments: Making lease payments for leased assets is also a financing activity.

Cash flow finance is a suitable option for small and medium-sized (SMEs) enterprises who find it difficult to access finance via traditional means, such as banks. For example, SME owners may opt for this method of financing if they have a low credit score with banks.

Cash Flow Funding Cost

The cash flow finance costs for businesses vary depending on the financing type and the loan terms. Here are some common costs associated with cash flow financing:

  • Fees: Some lenders charge fees for loan originating or providing ongoing services. These fees can include application fees, processing fees, and annual fees.

  • Interest rates: The interest rate refers to the cost of borrowing money, and it varies depending on the type of financing and the borrower’s creditworthiness. Typically, higher-risk borrowers will pay higher interest rates.

  • Collateral: Some lenders may require collateral to secure a loan, such as a lien on assets or a personal guarantee. The cost of collateral is the potential loss of the assets or the impact on the borrower’s credit rating if they default on the loan.

  • Opportunity cost: An opportunity cost is associated with taking out cash flow financing. This is the cost of not using the cash for other purposes, such as investing in the business or paying off other debt.

  • Early repayment penalties: Some lenders may charge a penalty if a borrower pays off a loan early. This penalty compensates the lender for the lost interest income and the costs of servicing the loan.

Key Takeaways - Cash Flow finance solutions

Cash flow financing is a useful option for businesses that generate significant cash flow from their sales but don’t have many physical assets to use as collateral for a traditional loan.

Examples of financing cash flow include invoice financing, factoring, merchant cash advances, and asset-based lending. Additionally, when considering cash flow financing, businesses should be aware of its various costs, such as interest rates and collateral requirements.

Usually, creating a cash flow budget in advance can help businesses identify possible cash shortages. However, in case a company faces a period of low cash flow and requires financing, cash flow finance can provide a solution. This type of financing can provide the necessary investment to help the business overcome the cash flow issue and continue its operations to generate profit and achieve healthy cash flow in the future.

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