Why a Business Loan might not solve your cash flow problems.
In this article, we’ll discuss the differences between fixed-term business loans and cash flow finance – and why a one size fits all approach to finance does not work.
Let’s look at this common scenario:
Jerry Smith runs a wholesaling business.
Jerry buys his products from local and overseas suppliers and has payment terms with those suppliers of between 0 and 14 days. His local suppliers have 14 day terms, whereas his imported goods require pre-payment (as well as the cost of shipping and insurances).
Jerry's wholesale customers have typical payment terms of 28-60 days.
Every time that Jerry logs in to his online banking, he is faced with a balance that reflects his payments going out to his suppliers – and a slow trickle over the next month of payments coming in from his customers.
This isn’t just a problem that Jerry or his industry face – this is a problem that all B2B businesses will face at some time.
Jerry still needs cash in his account to trade – he needs funds for his wages, funds for his overheads and funds in the account to cover those “rainy days”.
Jerry’s peers suggest that he might want to look at taking out a fixed term business loan to add a buffer to his cash flow and working capital. Jerry starts ringing around to his bank and a couple of non-bank lenders and gets a few options.
Ask anyone, not just Jerry, what time frame they want to pay back the business loan, and inevitably the answer will be “as long as possible, please and thank you”.
On the face of it, this makes sense. The capital is available to use within the business for longer and coming up with repayments is a problem for the future. But, is this the right answer in all cases?
How Business Loans work:
Typically, a Business Loan is a fixed term loan that puts cash directly into the business’s account. Because it’s a fixed term, the repayments will generally be the same amount on a recurring basis.
Is this an appropriate solution to bridge a cash flow gap?
While it’s definitely A solution, it may not be the best solution. Taking on external finance generally works best when the finance is working as hard for your business as you are. While you can’t expect it to be in your warehouse packing orders, you should be able to see a return on investment – your capital should be earning your business more than it is costing.
With the longer, fixed-term of a business loan, businesses can find themselves retaining expensive cash, sitting in an account slowly depreciating as a cash flow buffer or “rainy day” fund. Inevitably, when the business next requires additional working capital, a supplementary loan or “redraw” is required, again, locking the business into a fixed term of expensive cash.
How does cash flow finance work?
Cash flow finance is a unique solution which can provide control over cash flow. It is essentially a line of credit linked to and secured by a business’s outstanding accounts receivable and payable.
There’s often no real estate security and in some cases no capital repayment requirements.
Businesses will have access to the cash tied up in their outstanding credit sales upfront, to put back to work and seize opportunities, meet overhead costs, pay down debts, increase stock orders or steadily increase orders.
In other words, they can be free of many of the constraints that they may regularly face without such cash flow strength.
How does cash flow finance differ to a fixed term business loan?
Cash flow finance is a short-term, revolving finance solution to fill only the cashflow gap that the business is experiencing.
Typically, the debt is repaid as soon as the gap closes, and the extra capital injection is in use, earning additional revenue, for the whole time the business has it.
As a revolving facility, cash flow finance is available on demand for when the business needs it. As a short term finance solution, it can roll in and out of the business without the burden and stress of forecasting repayments into the future.
Whichever solution your business decides on, always look at the cost of the capital that will be in use. While some loans may seem cheaper or easier, the cost to the business can be hidden in the structure.
Cash flow finance - often the best solution to a cash flow problem.
Finstro offer an innovative line of credit, designed to support strong cash flow and business growth. Find out more by clicking the link below: