Uneven cash flow is cited as the top challenge for small businesses that often struggle to meet payroll or pay its bills. It can also be the main impediment to growth, forcing small companies to forego new opportunities that cannot be financed out of current cash flow. In many cases, cash flow shortages are short-term in nature as a business waits on a late payment or tries to muddle through a slow season. Without sufficient cash reserves, small businesses have to rely on outside financing, which is becoming more available through short-term cash flow loans.

What is a Cash Flow Loan?

Cash flow loans are a form of short-term financing that relies on a business’ cash flow or revenues as the basis for lending. A company borrows money from the cash flow it expects to receive in the future, and then the loan is repaid from that future cash flow. With traditional cash flow lending, collateral is not required, which makes it more suitable for companies that don’t have a lot of assets. However, the loans are typically underwritten based on an analysis of a company’s strength of earnings, past, present and future. Because the loans are short-term, less than three years, the interest rates are typically higher than longer-term loans; that and the fact that collateral is not used for loan security.

The secure cash flow financing from a traditional lending institution, a company would need good credit with the proven ability to maintain high margins on their balance sheets. Companies that undertake this kind of financing need to be able to repay a higher interest loan over a shorter period of time.

What About Businesses with Fair or Poor Credit?

The emergence of alternative lenders over the last decade has been a boon for small businesses that cannot even begin a conversation with a traditional bank because they are too new or have yet to build their credit. Alternative lenders, which primarily exist online, will underwrite short-term loans for as much as $250,000 for any business that has been in operation for one to two years. Using sophisticated computer algorithms, these lenders factor in many different types of data about the particular business, the industry, the market and the region in determining whether or not to approve the loan. Although they don’t rely on the business’ credit standing, they do consider the owner’s personal credit score, which doesn’t have to be great to obtain a loan.

The good news is that the application and approval process is fast and simple, with funding available in as little as two business days. The bad news is the interest rates on these loans can be much, much higher than traditional loans. The higher the owner’s credit score and the stronger the business’ sales, the lower the interest rate charged. Interest rates can range from a low of around 10% to over 100%.

Things to Know About Cash Flow Loans

Aside from the high interest costs, there are several things a business should know when considering a short-term cash flow loan:

Liens and Personal Guarantees: Because cash flow loans are considered unsecured business loans, some cash flow lenders will attach a general lien on the business to protect them from default. In addition, some lenders will also ask for a signed, personal guarantee, which can put the owner’s personal assets at risk.

Automatic Payments: To reduce their risk, it is common practice for cash flow lenders to require payments through a direct debit of the business’ bank account. Most business’ can handle that; however, often times the repayment terms are scheduled for daily or weekly debits, which could be problematic for some businesses with widely fluctuating cash flow. If a debit hits on a day when cash flow is negative, it could result in additional fees. Repayments based on a percentage of daily credit or debit card sales might be easier to manage.

When to Consider a Cash Flow Loan

The biggest consideration for any business looking a cash flow loan is whether it has the capacity to repay it as quickly as possible. Cash flow loans are meant to address temporary needs where there is a high expectation that future cash flow will be more than sufficient to cover the loan. Beyond that, businesses need to consider the reason for the loan and whether it provides the best possible solution.

Smoothing out a season cash flow cycles: Businesses that experience predictable peaks and valleys due to seasonal sales may be best positioned to plan for and handle short-term cash flow loans. A cash flow loan can provide the capital to meet expenses during the lull, while helping the business ramp up for the start of the season.

Launching new projects: When a business launches a new project or takes on a new customer, it often requires extra capital. With the expectation that the project or customer will generate additional sales within a few months, a cash flow loan would be most appropriate.

Pursuing an inventory discount: When the opportunity arises to purchase highly desirable inventory at a steep discount, a business could profit by using a cash flow loan to finance it. That assumes, of course, that the inventory can be moved quickly so the additional revenue can cover the loan.

Unexpected expenses: A broken water pipe or a malfunctioning piece of equipment usually can’t wait. If sales and profits are threatened, a cash flow loan may be the only solution.

Cash flow loans are not for every business. They can be expensive if relied upon too much and they may not be a long-term solution if a company’s cash flow problems are persistent. But, for companies experiencing steady growth with sound financial management, cash flow loans can aid in that growth when used in the right circumstances.