How to get business cash flow loans to bridge short-term liquidity bottlenecks
A cash flow loan is a short-term loan with a relatively small credit amount. It is mainly used by companies to bridge short-term liquidity bottlenecks. Here we show you what else a cash flow loan can be used for, what lenders look for and how to apply for it.
A cash flow loan is an unsecured loan granted by banks or other financial institutions to companies. It is used to increase working capital so that a company has short-term cash available to pay its bills, for example.
A cash flow loan is a short-term loan for companies, i.e. the term is usually shorter than 12 months. It is often used for the following purposes:
- Purchase of operating equipment and to stock up the inventory
- Hiring and training staff
- Bridging short-term liquidity bottlenecks, e.g. in the case of seasonal business
- Paying bills to maintain liquidity
- Renovate or modernise the business premises
- Expansion of the company
A common way in which a cash flow loan is granted nowadays is via crowdlending or special online lenders. The hurdles for a company to get a loan are often lower than with a bank loan. In crowdlending, for example, instead of one lender, there are several, which spreads the risk and often makes investors more risk-averse.
Typically, the loan amount for a cash flow loan ranges from £1,000 to £500,000, depending on the size of the business and its expenses. A cash flow loan is therefore much smaller than the investment loans needed for larger projects.
A cash flow loan works like a traditional bank loan. The lender assesses the default risk and determines the interest rate and the term of the cash flow loan based on this.
If a company takes out this loan, it pays the monthly repayments back to the lender over the fixed term. The interest rate is based both on the current base rate and on the risk with which the lender assesses the borrower. Interest rates can therefore range from 3% to 10%.
Both the lender and the borrower bear the risks in cash flow lending. Before lending, the lender should be aware of the risks it may face. As mentioned earlier, cash flow financing involves assessing the cash flows of a company for previous periods. However, a crisis, the departure of key customers, a sudden change in the political situation and other unforeseen circumstances and unexpected expenses can drastically reduce the future revenue of the business, and it will no longer be able to fulfil its financial obligations.
In addition, some industries experience seasonal peaks and are considered more volatile. For example, the agricultural business is mainly dependent on the harvest in any given year. A crop failure in one year or the entry of a new player with a better product and lower prices can destroy cash flow expectations. Therefore, the lender must realise that past performance does not always reflect future one.
An ice cream parlour has a booming business during the summer months, but sales drop sharply during the colder months. To avoid having to draw on reserves, the manager applies for a cash flow loan of £10,000, which is sufficient to cover operating costs during the autumn and winter months.
He agrees with the lender monthly instalments of £2,000 which he will pay back during the spring and summer months. The cash flow loan is easily granted because the lender can see on the ice cream parlour's income statement exactly what sales have been generated during the high season in recent years. Therefore, no collateral needs to be set aside.
Any type of company can apply for a cash flow loan. Whether the lender grants the sum depends on the risk and the creditworthiness of the company. If a borrower decides to use crowdlending, enough investors must show interest in the project or company to invest.
Short-term loans are usually given for a period of one month to one year. They are usually easier to obtain, as it is possible to foresee the immediate future with greater accuracy. In order for a small business to be approved for a cash flow loan, the manager needs to understand the application process:
1. Establish the financial need and its duration: the business manager must understand the needs the loan is being requested for. Perhaps the business manager does not have enough working capital to pay rent or employee salaries, or the business owner wants to increase production and purchase more raw materials before the high season. In any case, it is necessary to have a clear idea of what the loan will be spent on and in what time the business will get the fruits of its use and will be able to repay the lender.
2. Consider possible loan options: after establishing the purpose and terms, it is necessary to determine which of the available options for financing is suitable for you and to consider the interest rate at which loans are issued by different lenders. Also, don't forget to consider the terms of the loan: lender's fees, late fees, repayment terms and the reputation of the lender.
3. Make sure that you meet the requirements of the lender, who may ask for a certain credit score, sufficient turnover and the business existence, etc.
4. Applying for a loan: be prepared to provide your financial statements, such as balance sheets, income and cash flow statements for the previous years as well as your current financial situation, a detailed plan for the use of the loan and projections for future cash flows. A prepared cash flow plan will improve your position in obtaining a short-term loan.
5. Read the agreement carefully before signing: before accepting an offer, read the terms of repayment, hidden fees, penalties for early and late payments.
6. Getting the loan and monitoring: keep track of your cash flow to ensure timely repayment of the loan. You can use advanced cash flow monitoring and forecasting software to make it easier to keep track of your accounts.
Businesses have different options to apply for a cash flow loan. This can be with the bank where you also have your business accounts or with another lender, e.g. a crowdlending platform or another online lending company.
Every lender will expect an income statement from the last three business years in order to get an idea of the company's financial situation. It is important to document your financial situation as accurately as possible and also to show what income and expenses you expect in the coming months.
Depending on how the expected cash flow looks there, a loan can only be granted in a certain amount, because the income must be sufficiently high so that the loan instalments can be repaid without any problems.
Especially with online platforms, the processing time for the loan application is very short. Some providers make a financing offer within 24 hours, which can be a great advantage for companies in acute financial need.
The better a company's credit rating, the better its chances of obtaining a cash flow loan in the desired amount and at favourable conditions. However, it often happens that the credit rating is not excellent and a company already has cash flow problems that it would like to bridge with the cash flow loan.
In this case, lenders pay particular attention to the current situation: if it is foreseeable that the company will be able to repay the loan without any problems in a few months, the poor credit rating is not a reason not to grant the loan or to demand additional collateral.
It is possible that only a smaller sum than the desired amount will be provided and the interest rate will be somewhat higher than with a better credit rating. In any case, it is advisable for companies to compare offers from different lenders, because each one classifies the risks slightly differently and offers different conditions for a cash flow loan.
The main difference lies in the way the business is assessed to repay the loan. For instance, the lender needs to make sure that the loan they have granted will be repaid by the business on time. To do this, the lender can either make sure that there are further growing cash inflows due to past financial statements (cash flow lending), or, they can pledge the assets of the organisation they are going to lend the money to (asset-based financing), in this case business assets are used as collateral. Thus, it is preferable for a business to qualify for a cash flow loan as it does not jeopardise the property of the company.
Nowadays, businesses can choose from a wide range of funding solutions to manage short-term cash flow issues. A one-time injection of emergency cash can save a business and ensure improved financial performance in the long term. In addition to cash flow lending and asset-based financing, there are also:
- Peer to peer (P2P) loans provided by individual investors
- Love money - funds from your family and friends
- Invoice factoring
- Merchant cash advances
- Angel investors
- Venture capital
Overall, a cash flow loan can be an ideal solution for small businesses looking to get money as soon as possible. Cash flow loans are offered by many online platforms and are generally approved much faster than traditional bank loans. Once a business has the cash they need, they can quickly solve short-term cash flow problems and restore their financial health.