The definition of cash flow finance
Cash flow finance is a form of finance where a loan is made to a business backed by the company’s expected cash flow. Invoice finance (also known as debtor finance) is one of the most common forms of cashflow finance.
Using invoice finance, a business uses its invoices as security for a loan using the following steps:
- The business sends invoices to customers for products or services delivered.
- At the same time, the business sends the invoices to the cash flow finance lender.
- The finance company transfers a portion of the bill to the borrower. This is typically for up to 80 per cent of the invoice total. The process can be quick and be completed within 24 hours.
- The cashflow finance lender follows up with the company’s debtor and collects the amounts owed on the invoices.
- Once the invoice is paid, the remaining invoice balance (usually 20%) is transferred to the business borrowing funds, less any fees for the finance.
By using this form of finance, a company can free up the cash tied up in its accounts receivable to overcome cash flow problems. On the positive side, cash flow finance can be a quick way for a business owner to get the cash needed to cover operations. On the negative side, the cost of invoice finance can add up.
For example, one company charges 1.8% for the first 30 days and then 0.06% per day after thirty days. The interest can add up quickly with these types of credit terms, especially if a business uses this type of finance facility on an ongoing basis. If an invoice is more than 30 days overdue, 0.06% is equivalent to around 22% per year. Learn more in What Is Invoice Finance?
Online business loans based on cash flow
Since cash flow finance is defined as being backed by a company’s cash flow, other types of finance fit this definition. Online business loans are one example of this. Fintech business lenders such as Moula analyse the cash flow and other factors to determine whether a business will be able to repay a loan. As part of the process, Moula safely and securely analyses the banking and/or accounting data of a business to make a lending decision. If it’s determined that a business has the necessary cash flow to make the future loan repayments and meets other criteria, it will likely be approved for a business loan.
Cash flow finance as an alternative to traditional business loans
Cash flow finance is an important option for businesses that are not successful in getting traditional business finance. Many small businesses lack access to finance and have turned to cashflow finance as an alternative. One survey of SMEs showed that around 75% were rejected by banks when seeking finance. Another survey conducted in early 2019 uncovered that around 40% of SMEs have found it challenging to get business finance.
The challenge of getting business finance has grown as a result of the Banking Royal Commission and the fall in housing prices. Many business owners use their residential property as security for business loans. In early 2019, however, some banks have stopped this practice and no longer accept residential property as collateral for business loans. Other banks have decreased the loan-to-value ratio of their business loans. This means business owners can’t borrow as much based on the value of the property being used as collateral. For these reasons, more business owners are turning to cash flow finance as a way to get the funds they need.
Find out more in Working Capital: Why It’s Essential for Business Growth.