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What is a Cash Flow Loan?

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  • Written By: Malcolm Tatum
  • Edited By: Bronwyn Harris
  • Last Modified Date: 19 October 2018
  • Copyright Protected:
    2003-2018
    Conjecture Corporation
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Cash flow loans are loans that are extended based on the average amount of revenue that is generated on a monthly basis. For the most part, loans of this type are extended to businesses, with the funds often going to help cover some type of expansion or acquisition project, or to manage temporary increases in day to day operating expenses. A cash flow loan is also a common business tool used by companies that experience consistent shifts in revenue generation, based on seasonal sales.

With a cash flow loan arrangement, the lender bases the amount of the loan on the usual amount of cash flow that a company usually generates within a given period of time. In some cases, the time frame is monthly, and the focus is on the ability of the debtor company to remit a fixed payment each month, until the loan is retired. Some lenders, especially those that extend these types of loans to businesses that experience seasonal changes in their flow of cash, may look at the annual income generated by the business. When this is the case, the structure the loan may include quarterly or semi-annual payments that are due near the times of the year when the business is experiencing higher cash flows.

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A cash flow loan can be used in much the same way that an asset-based loan is utilized. Both types of loans may be used to expand existing facilities, open new facilities, augment temporarily lower cash flows, or even to launch a new product line. The difference is that the cash flow loan is extended based on the proven track record of collected revenue, rather than requiring that the company pledge one or more assets as collateral for the loan.

There is also a difference between a cash flow loan and a factoring loan. With a factoring loan, the lender is effectively buying the invoices generated for a particular period, and paying the business the face value of those invoices, less a small percentage. In return, customers submit their payments directly to the lender. The cash flow loan does not require any changes in remittance policies, or involve communication with the debtor’s customers in any way. As with most loan types, the borrower is responsible for making payments according to the terms and conditions noted in the loan contract. A business may have an active cash flow loan without customers knowing anything about the financial arrangement.

It is possible to couple an asset-based loan with a cash flow loan. Known as a senior stretch loan, this lending approach makes it possible to secure financing by using both the average rate of cash flow and some physical asset of the business, such as real estate that is owned by the company. In some instances, a senior stretch loan may be a good option, especially if the applicable rate of interest is lower than with either a cash flow or an asset-based loan.

A cash flow loan is not intended to be a long-term financing solution. Ideally, a company will take a long look at its operating processes and find ways to operate during slower seasons without having to borrow money. Reworking the cash conversion cycle, including taking steps to motivate customers to pay outstanding invoices in shorter periods of time, ultimately saves the business money, since it eliminates the need to pay finance charges on a loan.

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