When it comes to commercial finance, you typically have limited options. One option is to tap your own finances and inject equity into the business. You could also look for an outside investor. This works well in the startup phase, but is often difficult as your business grows. This is where a loan from a bank or finance company comes into play.
The various financing options out there are often confusing; however, there are really only two kinds that are applicable to small business owners -- cash flow financing and asset-based financing.
Both are viable options, but which is best for your business? What’s the difference between these two types of financing?
What Is Cash Flow Financing?
Cash flow financing is a loan that is backed by your company’s expected future cash flow. The amount of funding you expect is based on the historical financial performance of your company as well as your future projections.
Businesses typically use this type of financing for general working capital.
Examples Include:
- Making payroll
- Purchasing materials
- Taking advantage of early payment discounts from vendors
- Meeting urgent payables such as utilities or insurance
This form of financing is typically not used for large purchases such as equipment, real estate or vehicles. There are other types of financing that are more appropriate for that.
Other Forms Of Commercial Finance
There are many other forms of financing in the world of commercial finance, but the primary form outside of cash flow financing is asset-based lending. Just like it sounds, this is a loan based on a specific asset or assets.
This type of loan is typically used when purchasing fixed assets such as real estate or a piece of equipment. The loan is usually based on a percentage of a particular asset -- say 70% of the value of equipment or a piece of property.
Accounts Receivable As Collateral
Use your accounts receivable as collateral for a loan. This is a hybrid between a cash flow loan and an asset-based loan. The financing is based on the value of your accounts receivable, but the proceeds are typically used as working capital.
Factoring is a common form of this type of financing. A factoring company advances funds as a percentage of your accounts receivable. You receive a portion up front -- usually around 80% -- and the remainder when the invoice is paid, less the fee charged by the factor.
This lets you get cash as soon as you invoice rather than waiting 30 days or more for the invoice to be paid.
Finding The Best Financing For Your Business
Finding the best financing option for your business depends on what you need the funds for. If you’re just trying to make payroll or pay vendors more quickly, then a cash flow loan is probably your best option.
If you’re trying to finance a large purchase, then a term loan using your assets as collateral would make more sense.
Both types of financing are great. But each is best suited for a specific use. If you’re in doubt, talk to a reputable finance company. They look at the specific details of your financial situation and provide guidance.
Fast A/R Funding specializes in helping small businesses bridge the cash flow gap with factoring. Download our informative “Factoring 101” guide, or call 888.833.2286 to speak with one of our small business finance consultants.
