Cash Flow Financing: Is it the Way to Operate?

What is one of the best indicators of a healthy business? Cash of course! Cash is the lifeblood of any business. Without cash, you’ll have a very difficult time taking care of important things like paying vendors and meeting payroll.

Cash can be a tricky thing to manage though. Many businesses find that cash is tightest when they are growing – something every business wants to do!  But to keep enough cash to operate the business, growth may have to be scaled back – something most business don’t want to do.

How can you continue to grow your business without worry about having enough cash on hand to make critical payables? One option is cash flow financing.

What is Cash Flow Financing?

At its core, cash flow financing is simply a loan that is based on the cash that you expect to receive in the future. This is different from asset based lending where the funding you receive is based on the value of the assets pledged as collateral.

Reasons to use cash flow financing:

  • Your company is growing quickly.
  • You have to pay your vendors before you get payment from your customers.
  • Your cash flow is inconsistent, but you have regular expenses such as payroll.
  • You are concerned that about a large customer whose late payment could have a significant impact on your business.

An example of this type of financing is factoring. Factoring allows you to get cash immediately for invoices you have outstanding. Rather than waiting 30, 60 or 90 days for your customer to pay, you get the majority of the invoice in cash today and you get the remainder, less a small fee, when the invoice is paid.

Alternatives to Financing

Are there alternatives to managing cash flow without financing? Sure there are. Improving cash flow is a function of collecting cash quicker and/or paying expenses slower.

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Think of your cash flow like a bucket – a bucket you want to keep as full as possible. Cash comes out of the faucet above the bucket and goes out through holes in the bottom of the bucket. You want a big faucet at the top and tiny little holes in the bottom.

To bring cash in quicker you need a bigger faucet – work to increase sales and then collect on those sales as quickly as possible. This means offering shorter terms to your customer or offering a discount for early payment.

To slow your cash outflows, you need smaller holes that flow slower in the bottom of the bucket – reduce expenses and then take more time to pay those expenses. That means getting longer terms from your vendors.

Which Cash Flow Option is Best for Your Business?

There is no right answer to this question. It all depends on the nature of your business, your industry and the resources available to you.

To make the best decision, here are some things to think about:

  • Do you operate in an industry where it will be very difficult to get your customers to pay quicker?
  • Do you work with large companies that are likely to be inflexible in their payment terms?
  • Do you have the personnel to pursue past due invoices?
  • What is your cost of equity compared to the cost of financing your cash flow?
  • Do you have one or two large vendors whose on-time payments are vital to the operation of your business?

There is a cost to use cash flow financing, but that cost may be less than what you would spend to achieve a similar effect on your own.

As I mentioned above, there isn’t one answer that is right for every business. You need to weigh the pros and cons of each cash flow financing option to see which is the best for yours.

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