Your Business

Asset-based lending vs cash flow lending

Team Waddle  •  30 September, 2015

Whether you’re a start-up or a 100-year-old well-established company like Qantas, as sure as the sun rises, it’s almost a certainty that it has or will rely on borrowed capital.

When you set out to borrow money from a bank or alternative lending source (non-bank) to fund operations or make purchases you’ll comes across two major lending methods: Cash Flow or Asset-Based loans.

Cash Flow loans allow you to borrow funds based on future projected revenue, while asset-based loans allow you to borrow against assets on the balance sheet, which can come in many forms.

There's some advantages and disadvantages between the two, we’ll compare them and let you decide which one better suits you.

Cash Flow Lending

To be considered for a cash flow loan, lenders are primarily assessing the business owner’s personal credit, business credit and frequency of deposits (or consistency of cash flow). Lenders specifically will grant a loan based on future expected revenue that is anticipated from sales that can be determined by historical sales.

These loans generally do not require any type of physical collateral like property or assets. Instead, lenders examine expected future company incomes and its credit rating.

Banks usually underwrite cash flow-based loans by determining credit capacity. Typically, they will use EBITDA (a company’s earnings before interest, taxes, depreciation, and amortisation) along with a credit multiplier to calculate this figure. This financing method enables lenders to account for any risk brought on by industry sectors and account for any downturns that may occur.

Alternative lenders usually have a lower risk ratio, meaning that EBITDA does not hold as much weight and loans are granted more frequently. Generally alternatives to banks will seek out borrowers with high-frequency deposits that can meet the frequent repayment schedules that are offered as fixed term loans, repayable in equal instalments daily, weekly or monthly.

Cash flow lending is generally suited to businesses that maintain very high margins or lack enough in hard assets to offer as collateral to qualify for other types of business loans. Typical industries are retail and marketing firms.

Businesses that qualify for this loan type typically pay much higher interest rates than the alternative due to the lack of physical collateral that can be obtained by the lender.

Asset Based Lending

Asset Based Loans are always granted by securing funding lines against the lenders pre-determined value of assets offered by the business owner. This is usually offered as inventory, accounts receivable and/or other balance-sheet assets as collateral like equipment.

One of the most common assets offered by a business is either real estate or the receivables of the business. Asset-based loans are mainly suited to businesses that have stronger balance sheets and require larger credit lines to grow without being constrained to future projected revenue or EBITDA assessment.

Depending on a company’s credit rating or the credit worthiness of their customer base, they might be able to borrow anywhere from 75% to 90% of the face value of their accounts receivable line on the balance sheet and is generally offered as a revolving line of credit.

If a borrow was to seek out an asset-based loan and offer inventory or equipment as security, the amount granted against these assets would usually be lower as the value that might be recovered if you defaulted would be less at a future auction than what it’s worth today. Good asset-based lenders will allow a business to bolt on multiple types of assets to make up the funding base or credit line granted.

For example, if you had inventory and equipment, the lender might grant you a fixed limit up to say $100,000 against these assets and a floating limit of say $150,000 against your on-going receivables balance giving you a total credit limit of $250,000. The benefit of the receivables balance is that it’s not tied to the fixed assets of the business and as sales increase so will the amount you can borrow.

Businesses that qualify for this loan type typically pay a much lower interest rate than a cash flow loan due to assets offered as security.

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