Cash flow finance is a business finance option whereby funds are provided to a company based on that company's future expected cash flows. Those future cash flows are defined by a business’ accounts receivable ledger which shows a financing body what cash that business is expected to receive based on the value of its current and outstanding invoices.
Cash flow finance is, therefore, a different type of finance option from a traditionally long term and asset-backed business loan, where the loan amount is secured by a tangible asset. Also known as a ‘cash flow loan’, cashflow finance is available for any solvent businesses.
Defining cash flow
Cash flow is the total amount of money being transferred into and out of a business. One of the ways cash is generated is in the form of invoice payments. When those invoices are paid, cash comes into the business. That cash is then used to cover the business’ operating costs like overheads, capital assets and payroll. Whatever is leftover, once the cost of all expenses has been met, is the profit that a business makes. Poor cashflow management is the number one cause of insolvency in small businesses. It can stop a business growing, halt production to fulfil current orders and rack up debts with other suppliers. Failure to measure future expenses against future incomes can result in insolvency for an otherwise healthy and profitable business.
Cash flow problems can be substantially compounded for business owners offering payment terms to their customers. Payment terms are an agreed upon waiting period between a business and its customers for a customer’s invoice to be paid. For example, should a national retailer order a large quantity of stock from a smaller business, that business must purchase or manufacture the quantity required to fulfil that order before they are paid for providing it. They may have to wait months for the cash for that order to flow into the business accounts and they have expenses to cover in the meantime. Waiting 30 or 60 days for payment will force most companies in this position to fund their operating expenses through some form of cash flow financing.
What is cash flow finance?
All businesses, large and small, will require forms of cash flow finance at some point. Cash flow backed loans are available to any business and provide the cash needed for day to day operating costs. They are a short term form of funding typically used for working capital or for business expansion and offer a more flexible business line of credit than traditional fixed-term loans.
Essentially, companies that are financing cash flow are borrowing from the cash flows that they expect to receive in the future.
This is achieved by giving a financing company rights to an agreed portion of the receivables waiting to be paid. It allows companies to obtain funds straight away, rather than at some point in the future. It allows businesses to maximise opportunities and potentially grow the business, as well to more easily and effectively pay for daily operating activities.
The repayments for cash flow finance loans are based on a company's projected future cash flows. These are naturally considered higher risk than loans secured against a tangible asset and therefore cash flow loans generally demand a higher interest rate.
Cash flow lenders are typically focused on businesses with adequate levels of growth and margins. These types of loans vary in duration where longer loans are considered higher in risk.
Types of finance available
Choosing the wrong cash flow finance product for your business may further compound cash flow issues and put your business at risk of insolvency. Choosing the right product may see your business grow to its full potential.
For large corporations, there are considerably more forms of financing available which include options like offering additional shares to bespoke loans from banks. For smaller Australian businesses, business loans are most common; however, invoice financing options are also widely used.
A fixed-term loan is the most common type of small business loan. It is repaid at fixed intervals over an agreed period. Also known as an ‘unsecured business loan’, this type of loan is considered high in risk and therefore demands a high interest rate. The rates can be reduced substantially should the borrower offer collateral (such as tangible assets) as security. In this instance, it may be wise to pledge company assets to reduce the cost of the loan; however, pledging personal assets is generally considered poor practice.
Fixed repayments are generally non-negotiable once the loan contracts are signed. If your business has opted for a fixed-term loan, meeting those repayments as well as meeting the rest of the business’ expenses could further compound existing cash flow issues.
Invoice finance for cash flow
Another option for businesses is invoice finance, also known as debtor finance or accounts receivable finance. It is available for businesses in a couple of different ways; invoice factoring and invoice discounting.
This type of finance is generally offered as a cash advance on existing invoices awaiting payment. An invoice is effectively the promise of a future positive cashflow in writing for the given value of that invoice. So, it can be used as collateral for borrowing funds in the same way that tangible assets can be used for securing a business loan. Unlike a fixed-term business loan, the credit limit offered for invoice financing grows with the business and funds can often be accessed quickly, usually in 24 hours. This kind of cash flow finance is more closely aligned to what a business expects to be paid as it’s based on the current accounts receivable ledger and future expected income.
Cash flow funding in Australia
Invoice finance in Australia is a growing sector but it currently lags behind other markets in terms of adoption and awareness. The total size of the sector in 2017 was more than $75bn. This may sound like a large number, but it actually only represents 3% of the nation's GDP. In the UK, that number is almost 15% of the nation’s GDP.
So why aren’t Australian business owners using debtor finance facilities as much as their international counterparts? It’s probably down to awareness and availability. Globally it is seen as a regular part of doing business and is on offer to small businesses by most financial institutions. In Australia, companies tend to rely on traditional credit to meet cash flow needs.