Cash Flow Loans for Small Businesses: How Do They Work?
When you think about business assets, your cash flow may not come immediately to mind. But did you know that a positive cash flow can get you a business loan? Cash flow loans for small businesses can help owners get much-needed financing to sustain their operations and grow.
This funding option relies on how much money comes in and goes out of your bank account. Instead of focusing on collateral or high credit scores, cash flow lenders prioritize stable financials instead.
A major reason why small business owners are exploring this financing option is that they find it harder to get business loans from traditional banks. According to the 2023 Small Business Credit Survey, 37% of U.S. small businesses that did not apply for funding find the strict underwriting processes discouraging.
Of those who did apply for financing, 37% chose cash flow-based funding, such as a business line of credit or a merchant cash advance, over the past 12 months. Plus, nearly 60% used financing to meet operating expenses.
In this article, you’ll learn more about cash flow loans for small businesses, including:
What they are and their eligibility requirements
The types of cash flow financing
Their advantages and disadvantages
How to determine if this funding is right for your business
What Are Cash Flow Loans For Small Businesses?
Cash flow loans, which are typically collateral-free or unsecured loans, allow you to optimize or boost your working capital. Working capital refers to your available funds for short-term expenses, like salary, utilities, and debt repayment.
While cash flow lenders can still look at your credit score and history, they’re not the main deciding factor for approval. This is a plus for small businesses that have yet to establish these benchmarks.
Instead, the primary criteria for evaluating creditworthiness is solid financial performance, particularly future cash flow. This metric can be assessed through your historical and current bank statements.
Cash flow loans are typically used for:
Covering emergencies or cash flow gaps, such as invoice payment delays that will make it challenging to pay for day-to-day expenses
Time-sensitive investments, such as marketing campaigns, staff hiring, or equipment upgrades
Seasonal expenses, such as increased inventory to prep for peak seasons or holiday sales
Eligibility Requirements for Cash Flow Loans
To qualify for this type of loan, you will need to prove that you have healthy financials. Depending on the lender, you may be required to submit documents that show:
Income and revenue
Gross profit margin
Debt-to-income ratio
Historical financial performance
Financial forecasts
Number of years in operation
For providers who require business and personal credit scores, some may accept lower scores or even bad credit.
Advantages and Disadvantages of Cash Flow Loans
While cash flow loans for small businesses may have higher approval rates compared to traditional loans, there are benefits and risks to consider before applying.
Advantages of Cash Flow Loans
Faster and easier loan application process since there’s less paperwork
Fast release of funds
No limits on how you use the money
More accessible to new businesses
Can help build credit history and score
Disadvantages of Cash Flow Loans
Higher interest rates and fees (particularly origination fees) since the lender takes on higher risks
Lower loan amounts than traditional business loans, like real estate or SBA loans
A shorter repayment period
5 Types of Cash Flow Financing
Cash flow loans are under the bigger umbrella of cash flow financing. In general, cash flow loans can be short-term loans with a fixed or variable interest rate and repayment terms. However, there are other types of funding that also use cash flow and revenue to evaluate creditworthiness.
Below are the other common examples of cash flow financing.
1. Business Line of Credit
Like a business credit card, a business line of credit is a revolving fund you can draw from at any time and for any purpose. You also only pay interest on the money you withdraw.
Business lines of credit tend to have lower interest rates and higher credit limits to accommodate more expensive purchases.
This business funding option is also renewable, and repayment terms are more flexible than term loans. Approval requirements generally include a business or personal credit score and an annual or monthly revenue threshold.
2. Working Capital Advance
Working capital advances are a type of short-term funding based on the borrower’s revenue and cash flow. The primary purpose is to boost your working capital so you can pay for urgent expenses and take advantage of market opportunities.
The lender advances a lump sum, and then you make repayments at set intervals, such as daily, weekly, or semi-monthly. The main eligibility requirements include amount of time in business and annual or monthly revenue.
3. Merchant Cash Advance
With a merchant cash advance (MCA), a lump sum is given upfront in exchange for a percentage of your future debit or credit card sales. You connect your card processing system to the lender’s system, which automatically takes out payments from your daily or weekly card transactions.
MCAs have a factor rate that includes other costs and fees. The factor rate can be very high since it’s a multiple of the principal amount, typically between 1.2 and 1.5 (120% to 150%).
Application requirements can include your bank statements and your credit card processing statements.
4. Revenue-Based Financing
Similar to an MCA, revenue-based financing (RBF) also gives a lump sum in exchange for a percentage of your future revenue. Your payments depend on how much revenue you have during an agreed period (such as weekly or monthly). There’s also a factor rate.
The main requirement for this financing is your average monthly revenue. In general, there are no set repayment terms, and you can negotiate with the lender to establish your payment schedule.
5. Invoice Factoring
This type of business financing (sometimes called invoice financing) allows you to borrow against your accounts receivables or unpaid invoices. You typically receive 70% to 90% of the invoice amount upfront.
Once the customer pays the invoice, you will receive the remaining amount minus a factoring fee. However, depending on your agreement with the lender, you may be required to pay for any invoices that remain unpaid. This is known as “recourse factoring.”
Funding requirements can include an accounts receivable aging report and a profit margin matching your business's size.
Cash Flow Financing vs. Traditional Loans: How Do They Differ?
There are four main areas where these two types of financing differ:
Eligibility: Traditional loans, like asset-based lending (secured loans), have more complex requirements, including collateral or personal guarantees, business plans, tax statements, high credit scores, and established credit history.
Processing time: Since there are many documents to process, conventional loans can take weeks or even months to be approved. In contrast, cash flow financing can often be approved within a few business days or less.
Repayment terms: Traditional loans typically have strict monthly payments and prepayment penalties, whereas cash flow financing can have daily or weekly payments. Some cash flow lenders also don’t impose prepayment penalties.
Fees: Most cash flow financing have factor rates, while conventional loans have interest and annual percentage rates.
Should You Get Cash Flow Financing?
In general, cash flow financing can be more expensive than a traditional loan, so you need to carefully evaluate your business needs and finances. Cash flow funding is an ideal option if:
Your business has relatively stable income and consistent sales.
Your peak and slow months are predictable, so you know when you need funding the most.
Your business experiences seasonal fluctuations or is prone to invoice delays.
You have good cash flow management, meaning you regularly track, monitor, and forecast your income versus your expenses/debt.
You’re a growing startup that doesn’t have the credit history or the assets to apply for conventional loans just yet.
With so many loan options and providers out there, it’s best to compare them to determine which is the most well-suited and cost-effective for your goals. It’s also important to study their terms and disclosures to ensure you understand all the fees and conditions.
Get Alternative, Flexible Funding With Backd
While cash flow loans for small businesses can help fund operational expenses, other cash flow financing options might have more flexible terms. For example, Backd offers up to $2 million through our Working Capital Advance with daily, weekly, or semi-monthly payments.
Meanwhile, our Business Line of Credit provides up to $750,000. We also do a soft credit pull so applying doesn’t affect your credit score. Once you submit your application, a decision can be made within 24 hours.
Our eligibility requirements include:
$100,000 in monthly revenue
A credit score of 625+
Established business credit
Based in the U.S. with a brick-and-mortar address
Been in business for one year for Working Capital Advance and two years for a Business Line of Credit
Apply now to keep growing your small business.
