Almost every company will need to borrow money at some point in its operation. Regardless of your company’s stage, external finance offers the liquidity you need to pay your bills, acquire new suppliers and advertise your goods and services to new consumers.
When looking for finance, whether from a bank or a non-bank lender, you will come across two sorts of products:
- Asset-based loans
- Cash flow loans
Read on to learn more about each loan type and how they differ.
What is an Asset-Based Loan?
Asset-based loans allow you to borrow money against the assets you currently have on your balance sheet. When a borrower chooses an asset-based loan option, they can use several types of assets as collateral. The common types of assets used for this loan are:
- Accounts Receivables
- Real Estate
While larger businesses can utilize asset-based loans, small to medium-size businesses will typically find greater use of this type of loan to improve their short-term cash flow.
What is a Cash Flow Loan?
Cash flow loans provide money based on a business’s projected future sales and income. Rather than using assets to back a loan, this type of financing is issued to a borrower based on their historic and forecasted cash flows.
Companies that lack the assets to use as collateral typically find the most value in using a cash flow lending option.
What’s the Difference Between Asset-Based & Cash Flow Loans?
Both asset-based and cash flow lending have their pros and cons. You may profit more from one than the other or opt to employ a combination of the two to support your firm.
We will examine the distinctions and which form of loan is better suited for your needs.
Cash flow loans have no notion of collateral and rely entirely on the company’s capacity to produce future income. The borrower’s credit rating is an essential factor in determining whether or not to provide cash flow-based loans.
On the other hand, asset-based loans consider the company’s current assets and what may be used as collateral. In the case of a loan failure by the borrower, the lender can use such collateral assets in the future. If the borrower cannot satisfy the payment requirements, the lender has the right to hold a lien on the assets and utilize the revenues of their sale.
Asset-based loans are not appropriate for all businesses, just as cash-flow-based loans are not appropriate for others. The company’s credit rating is essential in deciding how much or if a firm may borrow in the first place.
Cash flow loans are best suited for companies with excellent credit and a substantial, verifiable cash flow. Asset-based loans are better suited to borrowers with a limited cash flow or a bad credit rating. The value of the assets must be large enough for the bank or other lender to take a chance on the loan.
Because the objective of each form of loan is so varied, the criterion utilized to issue loans is also reasonably distinct. EBITDA is a common criterion for granting cash flow-based loans. A typical component computed by lenders is EBITDA (earnings before interest, taxes, depreciation and amortization) in conjunction with a credit multiplier. This process helps factor in any risks that may occur due to economic downturns or industry-specific shortages.
Cash flow loans are typically easy to obtain because there is no collateral required to support the loans. This is particularly appropriate for SMEs and MSMEs and in the aftermath of the epidemic, banks and NBFCs should focus on cash flow-based financing to acquire new clients.
Which Type of Loan is Right For My Company?
Which choice is better for your company? The answer to this question is heavily influenced by what you have and what you require. The loan you pick should be suited to your company’s unique needs and characteristics.
Porter Capital offers various working capital solutions to businesses all over the country in various industries such as staffing, freight, manufacturing and more. Our company also specializes in many services, such as accounts receivable factoring and DIP financing.
Since our inception, Porter Capital has provided over $6 billion in capital to our clients. To learn more about our financing solutions, get in touch with us today!