How Cash Flow Impacts Your Lending Options

Companies borrow money based on their projected cash flows through cash flow-based financing. A firm partakes in cash flow lending when they borrow money from projected future revenue. Financial institutions grant loans guaranteed by the recipient's past and future cash flows, but credit ratings also play a major factor in this type of lending. 

Although these loans do not require securities, some cash flows used in the underwriting process are typically secured. These loans usually come with higher interest rates because the requesting company lacks tangible assets that the lender could take if they defaulted. 

Lenders look at a company's predicted future earnings, credit rating, and enterprise value when deciding whether or not to originate a cash flow loan. Companies can obtain financing faster with this strategy because they do not need to complete a collateral appraisal. Financial institutions typically use earnings before interest, taxes, depreciation, amortization (EBITDA), and a credit multiplier to underwrite cash flow-based loans.

Cash flow loans are better suited for companies with solid margins or those that lack tangible assets as collateral. Some companies that may fit these criteria include service providers, marketing firms, and low-margin product makers. 

Take a marketing company trying to meet payroll, for example. They can rely on cash flow financing to pay employees upfront and repay the loan and any interest on the profits and sales generated by the employees at a later date.

What is a Capital Loan?

Capital loans are interfund loans or components of interfund loans that pay for the design, acquisition, construction, installation, or improvement of real or personal property. The money from the loan does not fund operating expenses. 

Cash Flow From Assets

The total cash flow from all of a company's assets is called cash flow from assets. It impacts the amount of cash a company spends on operations during a given period. However, money from other financing sources, such as selling stocks or borrowing to offset negative cash flow from assets, is not considered.

Cash flow from assets includes three categories of cash flow:

1. Cash flow from operations

The net income earned after covering business costs is included in the cash flow created by operations. It also takes into account any non-cash expenses. Amortization and depreciation are two examples of non-cash expenses.

1. Working capital changes

Working capital refers to the net change in inventory accounts receivable and accounts payable over the measurement period. Your organization should strive to lower its working capital level to demonstrate that you have earned money. If you show an increase in working capital, it highlights that you have spent money. 

1. Variations in fixed assets

Changes in fixed assets refer to the net change in fixed assets before depreciation is taken into account. Depreciation is the study of specific expenses associated with an asset's long-term costs, and it is an out-of-pocket expense.

What are the advantages of tracking cash flow from assets?

Tracking cash flow from assets sheds a light on a company’s financial health. The cash flow from assets metric illustrates how much money a company spends on operating expenses. It also shows where and how a company spends money.

Investors also have an interest in cash flow from assets, so it is crucial to track it for their sake. With the existing capital operation and structure, cash flow from assets also shows cash spending or spin-off. These help investors assess a firm’s true worth or what it should be valued at. 

Cash flow from assets also gives investors insight into the assets they may use to pay down debt or to cut spending and increase its worth.

Methods for Increasing Cash Flow from Assets

Positive cash flow from assets is crucial for a firm since it produces money rather than merely spending it. The following are some ways that can help you establish a more positive cash flow:

• Rising prices

• Reducing operating costs by eliminating overhead charges

• Increasing the time between payments to suppliers

• Redesigning items with more cost-effective designs to cut material costs

• Switching to lease financing alternatives when purchasing new fixed assets

• Credit restrictions to decrease the amount of money invested in accounts receivable

Asset-Based Lending

Asset-based lending involves a loan that is backed by an asset. To put it simply, the lender's loan is secured by the borrower's assets. Borrowers may use accounts receivable, inventory, marketable securities, and property, plant, and equipment (PP&E) as assets to secure a loan.

This type of lending is deemed less risky than unsecured lending. In unsecured lending, the loan is not backed by any assets. An asset secures the loan in asset-based lending, so the interest rate charged is lower. The more liquid the asset, the lower the interest rate goes and the less dangerous the loan is perceived.

For example, an asset-based loan secured by accounts receivables is considered safer than an asset-based loan secured by a property. The property is illiquid, so the creditor may find it difficult to liquidate the asset rapidly on the market if needed.

Advantages of Asset-Based Lending

Asset-based loans are easier and faster to obtain than unsecured loans and lines of credit. They also typically have fewer covenants and lower interest rates than other financing choices. For the lender, asset-based loans are less risky because they are secured by an asset. If the borrower defaults on the loan, the lender can seize and liquidate the assets used to secure the loan to pay off the debt.

Bottom Line

Borrowers have many different equipment financing options available. Equify Financial is here to make the process seamless. We would love to go over your options and see how equipment financing can benefit your business. You can contact our team whenever you are ready!