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Cash-Flow Financing Definition
Cash flow financing refers to a form of funding where you back a loan made to the company by the expected cash flow of that particular company. It is different from an asset-backed loan, where the loan’s collateral is based on the assets of the company. The cash-flow loan’s repayment plan is based on the projected future cash flows of the company.
A Little More on What is Cash-Flow Financing
Companies us cash-flow financing when they want to make a significant purchase, acquire another company, or when in need of cash to finance their operations. In other words, companies borrow from cash flows expecting to receive in the future by giving a portion of their receivable’s rights to another company.
The technique makes it possible for companies to obtain a financial boost today, rather than in the future. One of the primary reasons for companies obtaining cash flow financing is for them to meet timely payroll requirements and operational expenditure.
How it Works (Examples)
Let’s assume that ABC Company has hired additional personnel, and it requires money to fund their payroll. The company happens to have a stream of cash flow that is reliable coming from their rental houses on the 20th of each month. However, it needs money to cover for payroll on the 1st. So, the ABC Company decides to use cash flow financing to acquire a short-term loan to cover the new staff’s payroll expenses and then repay using receivable from the rental houses on the 20th.
Basics of Cash Flow Financing
Companies that show cash inflows steady growth and the ones that suit well with cash flow financing. It is because, to generate additional revenue, they will need an upfront investment. The primary thing a cash flow provider will look out for is a business with net income that can cover all the existing debts and, at the same time, handle extra debt with further cash inflows.
Note that there are cash flow loans like a line of credit, term loan, or working capital that require payments to be done on a weekly, bi-weekly, or monthly. It is the reason why you may want to use loan proceeds to help in project financing to boost the growth of your business.
Common Cases where you can use a Cash Flow Financing
- Preparing for peak periods
There are those small businesses that are seasonal. Such firms, at some point during the year, will require additional funds to be able to prepare adequately for the peak season, which usually comes with high demand.
For example, we have small businesses that deal with selling gifts. Such enterprises may experience influx during the Christmas season when families and friends buy plenty of gifts for their loved ones. They can seek for cash flow financing and use the off-peak period to prepare for the peak periods.
- Invest in Inventory and Equipment
Some companies may need to buy additional equipment and inventory to help cover the high demand that results from things such as strong sales record. Cash flow financing will come in handy in such situations.
- Lock-in a Good Deal
Sometimes your business may get a game-changing opportunity involving a large amount of money with limited time to strike the deal. In such a case, you can make use of cash flow financing to acquire funds so that you don’t miss out on the deal.
- Hiring Additional Staff
A company may be in urgent need of additional staff to fill up essential roles. This means that it will need some extra cash to facilitate salary payment. In such a case, the firm may turn to cash flow financing for the money they will require to hire the other staff.
- Open a New Location
A firm may also need additional funds to expand the business, such as opening more brunches to meet customers’ demand. A good example is the owner of Joe Coffee, who had successfully opened ten outposts using sales as well as family and friends revenue.