Many or all of the products and brands we promote and feature including our ‘Partner Spotlights’ are from our partners who compensate us. However, this does not influence our editorial opinion found in articles, reviews and our ‘Best’ tables. Our opinion is our own. Read more on our methodology here.
Cash flow is what makes your business tick. But cash isn’t always flowing in the right direction. Whether it is due to seasonal trading, unexpected bills, or increased hiring costs, you may find yourself short of the money you need to cover your day-to-day operations.
A cash flow loan can act as a short-term solution to this problem, providing an injection of funds to help with your business costs during periods of inconsistent trading.
Read on below for our guide to cash flow loans, including what you can use them for, their pros and cons, and how to apply for one.
» MORE: Four steps to make a cash flow forecast for your business
What is a cash flow loan and how do they work?
In many ways, a cash flow loan works like any other loan. You borrow the amount you need to cover your costs, and then you repay that sum, with interest.
However, they can differ from traditional, long-term business loans in a number of important ways:
- Cash flow loans are typically based on future revenue: Instead of basing your eligibility on the assets you own, cash flow loans are unsecured. Lenders will be interested in your past and future cash flow, and base the amount you can borrow on your estimated future revenue.
- Business performance matters more than your business credit score:While your business credit score will be taken into account, lenders will be more interested in your past and estimated future performance when considering you for a loan.
- Cash flow loans are quicker to obtain:If eligible, your application will be approved much faster with a cash flow loan than with a standard business loan.
- They are designed for short-term use only:You will be expected to pay back your cash flow loan in months, rather than years. Although the repayment schedule will vary from lender to lender and loan to loan, it is usually between one and 12 months.
- They come with higher interest rates and fees:Due to being both unsecured and short-term, cash flow loans will normally have higher interest rates and fees than a traditional business loan.
- You may need to make a personal guarantee:This means that, if your business defaults on the loan, you will become personally liable for paying the remaining sum.
What can I use a cash flow loan for?
There are a range of reasons why your business may need to consider a cash flow loan. These include:
- paying day-to-day business costs, such as rent, bills and wages
- covering seasonal dips in trading
- hiring extra staff – for example, to deal with seasonal demand
- purchasing stock
- buying or hiring essential business equipment
What are the advantages and disadvantages of a cash flow loan?
For businesses with immediate money problems, but lacking a substantial credit history or the assets required for a secured loan, cash flow loans have certain benefits.
- They are quick to obtain.
- You won’t need to put up any assets or collateral.
- Businesses without a strong credit history can access them.
- They can help improve your credit score if they are paid off in a short period of time.
But, as with all forms of lending, it is vital that you pay attention to the potential drawbacks of cash flow loans before applying.
- They are only suitable as a short-term solution, not a long-term fix, to cash flow problems.
- Interest rates are typically higher than with other business loans.
- Origination fees (i.e. the fee a lender charges for processing the loan) and late payment charges are typically higher than with other business loans.
- You may need to make a personal guarantee, meaning you are liable for repayments if your business defaults.
- Some lenders may require automatic payments, meaning you will need to pay regardless of whether you have the funds available.
Other types of cash flow lending
Alongside unsecured cash flow business loans, there are three other main types of cash flow finance.
Merchant cash advance
If your business frequently receives debit and credit card payments from your customers, then you could look into a merchant cash advance.
You would receive a lump sum payment from the lender, who will then be repaid through a pre-agreed percentage of your future debit and credit card transactions until the amount borrowed is cleared.
Revolving credit facility
If you want greater flexibility with your borrowing, then a revolving credit facility might be the right fit for your business.
It is a form of business credit line, and allows you to withdraw and repay funds as and when you want for the length of your agreement.
Say you had a maximum limit of £10,000. You borrow £2,000 from that amount, to be repaid over three months. You will only pay interest on the £2,000 you have taken out. Once that sum is completely cleared, you will again have access to the full £10,000, as long as you are still within the agreed borrowing period.
Invoice finance
If your business involves regularly invoicing clients, then you may want to consider invoice financing. This is where you borrow money against your unpaid invoices.
There are two main types of invoice financing: invoice factoring gives your lender control over chasing your clients for payments, while invoice discounting leaves that job up to you.
How can I apply for a cash flow loan?
When looking to apply for a cash flow loan, you will likely need to provide the following information:
- your business details, such as registered address and name
- the number of years you have been trading
- your average monthly turnover or card sales
- the amount of money you are looking to borrow
This will help the lender assess your eligibility, and whether or not you are suitable for a cash flow loan.
You will then need to follow the specific application instructions of your chosen lender.
Image source: Getty Images
About the Author
Dive even deeper
How to Choose a Company Structure and Register a Business
by George Harrison
What is Accounts Payable?
by Henry Williams