What is Small Business Cash Flow Lending?
Small Business Cash flow lending is loaning money to companies based on the projected future cash flows of that company. A small business cash flow lender grants a loan that is backed by the business cash flows. By definition, this means that a company borrows money from expected revenues they anticipate they will receive in the future. Credit ratings are a bit more important in this form of lending, in addition to historical cash flows.
For example, a small business that is attempting to meet its payroll obligations might use cash flow finance to pay its employees now and payback the loan, any interest on the profits and revenues generated by the employees on a future date. These loans do not require any type of physical collateral like property or assets. Instead, small business cash flow lenders examine expected future company incomes, its credit rating and its enterprise value.
The advantage to this method is that a company can obtain financing much faster, as an appraisal of collateral is not required, and underwriting time is minimal.
Institutions underwrite cash flow based loans by determining credit capacity. Typically, they will use EBITDA (a company’s earnings before interest, taxes, depreciation, and amortization) along with a credit multiplier to calculate this figure. This financing method enables lenders to account for any risk brought on by sector and economic cycles. During an economic downturn, many companies will see a decline in their EBITDA, while the risk multiplier used by the bank will also decline. The combination of these two declining numbers will reduce the available credit capacity for an organization.
Cash flow loans are better suited to small businesses that maintain high margins on their balance sheets or lack enough in hard assets to offer as collateral.
Small businesses that meet these qualities and are a perfect fit to utilize cash flow loans include: retail stores, craft breweries, restaurants, healthcare practices, manufacturers and wholesalers. Interest rates for these loans are typically higher than the alternative due to the lack of physical collateral that can be obtained by the lender in the event of default.
As the name indicates, the lender is more concerned with inspecting your cash flow (usually bank statements) to approve your application. Turnaround time is another great feature of a cash flow loan, as funding usually takes place in a matter of days.
A cash flow loan may be used for any business expense, but some common uses are:
- Working capital
- High ROI short-term opportunities
- Purchasing highly-discounted inventory
- Business expansion
Most small business cash flow loans come with either a fixed daily (every business day) or weekly ACH payment. Repayment for a small business line of credit is automatically deducted on a weekly basis. While some lenders still accept payment by check, electronic payments have become increasingly common, particularly with online lenders.
Electronic Payments are Good for the Lender and Good for the Borrower
A daily or weekly ACH debit makes sense for lenders because it reduces the costs associated with processing a loan payment, ensures that payments are made in a timely fashion, and makes it possible for the lender to identify potential repayment issues within a couple of days, rather than several weeks—giving them enough time to try to help borrowers get back on sound financial footing and meet their commitments.
- ACH payments save the business owner money - roughly $1.22 per check
- It is convenient for the borrower who doesn’t need to take the time to write a check (particularly if the ACH debits are scheduled and automatic)
- The regular and timely payments help build and maintain a strong business credit profile
Daily or weekly debits, as opposed to a monthly debit, reduces the size of each periodic payment making it easier for many borrowers to smooth their cash flow and avoid contributing to “lumpiness” in having large expenses due at the end of the month. This type of electronic direct debit makes capital available to some borrowers who might not qualify within a more traditional payment model.
Making ACH Business Loan Payments Work for Your Business
Millions of ACH transactions happen every day, but that doesn’t mean much if you can’t make it work for your business. With that in mind, here are 3 things that will help you do just that:
#1. Make sure you have the right kind of cash flow to accommodate the periodic payment frequency. If most of your monthly revenue is attributed to a handful of customers that make payments at the end of every month, a daily or weekly ACH pull from your business checking account might not work and may disqualify you from some loan types. This is one reason most online lenders want to see the last three or four months of bank statements. They want to make sure your cash flow will support the debit frequency (daily or weekly).
#2. Make sure you understand the amount that will be pulled with every periodic payment: A fixed payment will likely be easier to budget for. You’ll also want to determine if payments are only made on weekdays or if they will also take place on the weekends. The more you understand about the process upfront, the better you will be able to budget and prepare for each periodic payment.
#3. Make sure you understand what happens if you don’t have sufficient funds in your account: Nobody wants this to happen, but if it does, what does that mean for your loan? Making sure there is always enough in the account to make the automatic payment needs to be a priority, but sometimes circumstances might leave a business owner short. Most of the time, you’ll know before the payment is due. If that’s the case, reach out to the lender before the payment is attempted to try to make other arrangements.
Making payments electronically is an innovation designed to make small business loan payments seamless and easy for both the borrower and the lender. Ready to see if an ACH small business loan makes sense for your business? Call (855) 998-5874 or click below.