Business insights and growth highlights

Asset Based Loans Vs Cash Flow Based Lending

Feb 24, 2022 by Morris Reichman

Figuring out the best way to get funds for your business is always an uphill battle. If you’re experiencing cash flow issues or simply need funds to expand, you will probably need to turn to a lender. However, no two lenders are exactly alike, and some lenders offer different kinds of loans than others. For example, you may qualify for an asset based loan through one bank or lending company and a cash flow based loan through another.

So, what do these terms actually mean? Which type of loan is better for your business? Finally, how do both of these options compare with payroll financing? In today’s guide, we will answer all of these questions and more, but first, let’s define what each of these loans actually does and how your business can qualify for them:

What Is An Asset Based Loan?

An asset based loan is a type of lending that is secured by collateral. For this reason, asset based loans are frequently known as “collateral based loans.” When you apply for an asset backed loan, you have to show that your business has assets of value that can be used as collateral in the event that you fail to repay the loan in full within the terms of the lending agreement.

Types Of Asset Based Loans

The type of assets you use as collateral can vary based on the lender’s requirements, as well as the nature of your business. For example, a manufacturing business would likely put equipment or inventory up as collateral, while a business with fewer tangible assets would likely depend on accounts receivable. We will go into greater detail about all of the different kinds of assets you can use to acquire an asset based loan in the sections below:

INVENTORY
In order to engage in inventory financing, your business must be in possession of products that will not be immediately sold off. For example, if you acquire inventory from suppliers and that inventory sits in a warehouse before sale, you can probably use it as collateral to secure an asset based loan. However, if the inventory only stays in the possession of your business for a very short period of time, you likely will not qualify for inventory financing.

EQUIPMENT
Equipment financing is a bit easier than inventory financing, as most equipment that is integral to your business is something that you own. However, this also means that you are putting your business at greater risk. If you find yourself in a position where you cannot pay back the loan, you could lose some of the most vital and valuable machinery and equipment needed to run your business. Therefore, you should never jump into equipment financing unless you can afford to lose whichever pieces of equipment you plan to use as collateral.

ACCOUNTS RECEIVABLE
Accounts receivable financing can be arranged in a number of different ways. That said, it always allows you to get a set influx of cash based on your pending payments (i.e. accounts receivable) from clients. For example, if you have $50,000 in unpaid invoices, you may be able to secure a loan for half of that amount from an accounts receivable lender. As your clients pay their bills, you will need to forfeit a portion of these payments (plus interest) in order to repay the loan.

REAL ESTATE
Finally, you can always put commercial, industrial, or even residential real estate up as collateral for an asset based loan. Like most types of asset based loans, this means that you could risk losing your real estate investment if the loan is not repaid. Therefore, you should be wary of using land as collateral, particularly if the property serves an essential purpose for your business operations.

What Is A Cash Flow Based Loan?

Essentially, a cash flow based loan is the opposite of an asset based loan. With an asset based loan, you are required to put up some form of collateral to qualify for the loan. Your business income has very little impact on your ability to secure an asset based loan, though better cash flow could still theoretically help you get better interest rates and repayment options. In any case, a cash flow based loan does not require any form of collateral. As the name implies, the loan is based on your business’ past cash flow and projected revenue for the future.

Typically, business loans based on cash flow are meant for the short term. This is due to the fact that cash flow cannot always be accurately predicted for long periods of time. Therefore, lenders will want to be repaid while you can still guarantee a certain level of cash coming into your business.

However, this also means that cash flow based financing can be risky for both the lender and your business. If a sudden change in your industry or business results in reduced cash flow, it could hinder your ability to repay the loan on time. Alternatively, if you have been extended credit based on cash flow, reduced revenue or heightened expenses could result in a sudden retraction of your credit limit. Either way, going into a cash flow based loan means that you are putting all of your trust in your business’s ability to maintain and grow its revenue over the course of the loan term.

While cash flow based loans can be easier to secure (since they don’t require collateral), they do not always have favorable repayment terms. You will likely encounter higher interest rates, shorter repayment lengths, and hefty penalties for late payments. In any case, if you have a business with a consistently healthy cash flow, this type of loan is a great way to secure even more cash to expand your business even further.

Payroll Funding Vs Alternative Cash Flow Backed Loans

If you’ve ever decided to go with a Merchant Cash Advance (MCA), then you likely already see the similarities between an MCA and a cash flow backed loan. This is because an MCA is essentially a type of cash flow based loan that takes a percentage out of your future sales to pay back the loan, the accumulated interest, and fees. Consequently, MCAs and other alternative cash flow backed loans can get very expensive, very quickly.

On the other hand, payroll funding is a great way to get a quick influx of cash to help you cover payroll expenses while you wait on invoices to be paid. In other words, if your business has a short-term cash flow issue, then you should contact a payroll funding company. Most other types of business financing require you to have ample assets to use as collateral or good cash flow.

So, is a small business loan for payroll right for you? If you’re interested in learning more about the advantages of payroll funding, feel free to reach out to Payro Finance today!

Morris Reichman

hello@payrofinance.com

Morris Reichman is the founder and CEO of Payro Finance. Former Vice President at Infinity Capital Funding an alternative finance company, Morris possesses a versatile background in the finance industry. Having spent 7+ years working across global macro operations and start up corporate finance Morris's expertise is in business accounting, risk management and investment analysis. Morris founded Payro Finance to support business owners and ensure their business continuity.