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Overview

Cash Lending based on Flow

Asset-Based Lending

Key differences

Business Credit Underwriting

Financial Lending FAQs

The Bottom Line

Corporate Finance Corporate Finance Basics

Cash Flow and. business lending based on assets What’s the Difference?

By James Garrett Baldwin

Updated October 08, 2022.

Reviewed by Amy Drury

Cash Flow and. Business Lending based on Assets A Comprehensive Overview

If a business is a startup or a 200-year-old conglomerate such as E. I. du Pont de Nemours and Company (DD), it relies on borrowed capital to operate like cars run on gasoline. Business entities have many different options in borrowing which can make business borrowing a bit more complicated than personal borrowing options.

Businesses may decide to take out money from banks or other institution to finance their operations, buy another business, or take part in a major acquisition. For these purposes, they may be possible to look at a variety of lenders and choices. In general the business loans, like personal loans are structured as either secured or unsecured. Financial institutions are able to provide a range of lending provisions within both of these broad classifications that can be tailored to each individual borrower. The unsecured loans are not backed by collateral, while secured loans are.

In the secured loan category, companies may look at asset-based or cash flow loans as an option. Here we will look at the differences and definitions of the two along with some scenarios on when one is more preferred to the other.

Important Takeaways

Both cash flow-based and asset-based loans are typically secured.

Cash flow-based loans consider a company’s cash flows when determining the loan conditions, while asset-based loans look at assets in the balance sheet.

Cash flow-based loans could be a better option for companies without assets such as service companies or for entities that have greater margins.

Asset-based loans are typically better for companies with strong balance sheets that might operate with tighter margins or unstable cash flow.

Cash flow-based as well as asset-based loans can be good options for businesses seeking to efficiently reduce their credit costs, as they’re both secured loans which typically have higher credit terms.

Cash Lending

Cash flow-based loans allow businesses to take out loans based on the projected coming cash flow flows for their company. In the case of cash flow lending, an institution provides an loan that is backed by the recipient’s past and future cash flows. This means that a company borrows cash from the expected revenue they anticipate receiving in the near future. Ratings on credit are employed in this form of lending to serve as an important factor to consider.

For example, a company trying to meet its payroll obligations might use cash flow finance to pay its employees now and pay back the loan as well as any interest accrued on the earnings and profits earned by employees at the future date. The loans do not require any kind of physical collateral such as assets or property, but a portion or all cash flows utilized for underwriting are typically secured.

To underwrite cash flow loans The lenders evaluate expected future company incomes as well as its credit score and its enterprise value. The advantage of this method is that a company can be able to obtain financing faster since the appraisal for collateral isn’t needed. Institutions typically underwrite cash flow-based loans using EBITDA (a company’s profits before tax, interest, depreciation and amortization) along with a credit multiplier.

This type of financing allows lenders to account for any risk caused by sector and economic cycles. During an economic downturn, many companies will see decreases in their EBITDA as well as the risk multiplier used by the bank will also fall. Combining these two declining numbers can reduce the available credit capacity for an organization , or even increase the rate of interest for those who have provisions made to be based on these criteria.

In the case of cash flow loans are more appropriate for companies that maintain high margins or lack sufficient physical assets to use as collateral. Companies that meet these qualities include service providers or marketing firms as well as producers of low-cost goods. Interest rates for these loans tend to be more expensive than alternatives because there is no physical collateral that can be obtained through the loan provider in the case in default.

Both cash flow based and asset-based loans are typically secured by the promise of assets collateral or cash flow in the loan bank.

Asset-Based Lending

Asset-based loans allow companies to borrow money by calculating the liquidation cost of their balance sheet. The recipient is provided with this type of financing by offering inventory, accounts receivable and/or other assets on the balance sheet as collateral. Even though cash flows (particularly ones linked to physical asset) are considered when making the loan, they are secondary as a determining factor.

Common assets used to secure an asset-based loan are physical assets such as real property, land such as inventory of companies machines, equipment, vehicles, or physical items. Receivables can also be included as an asset-based loan. Overall, if the borrower is unable to repay the loan or defaults, the lending institution is able to levy the collateral, and is able to obtain approval to levy and sell the collateral in order to recoup defaulted loan values.

Asset-based lending is better suited for businesses with substantial balance sheets, and have lower EBITDA margins. This can also be good for companies that require funds to expand and operate especially in sectors which may not have a significant cash flow potential. A capital-based loan could provide a business with the needed capital to address the issue of slow growth.

As with the majority of secured loans, loan to value is an important factor in credit based on assets. The creditworthiness of a company and its credit score will determine the loan to value they are eligible for. Typically, high credit quality businesses can borrow between 75 percent to 90% of the face value of their collateral assets. Firms with weaker credit quality might only be able to obtain 50 to 75% of the face value.

Asset-based loans typically adhere to a strict set of guidelines about how collateral is treated of the physical assets used to obtain a loan. In addition, the company usually cannot provide the assets in the form of collateral to other lenders. In some cases there are instances where second loans to collateral are illegal.

Before authorizing an asset-based loan lenders may require an extremely lengthy due diligence procedure. This may consist of a thorough examination of tax, accounting and legal issues along with the analysis of financial statements as well as asset appraisals. Overall, the underwriting for the loan will determine its approval , as will the rates of interest and allowable principal .

Receivables lending is an illustration of an asset-based loan which many businesses employ. In receivables lending, a company is able to borrow funds against their receivables accounts to bridge a gap between revenue recording and the cash receipt. Receivables-based lending is generally an asset-based loan as receivables usually secured by collateral.

Some companies prefer to keep the ownership of their assets rather than selling them off for capital as a result, they are willing to charge interest charges to borrow money on these properties.

Key Differences

There are fundamental differences between these forms of lending. Financial institutions that are more interested in cash flow lending focus on the future of a company, whereas institutions that issue assets-based loans adopt a long-term view by prioritizing current balance sheet over future income statements.

Cash flow-based loans do not require collateral. asset-based lending is rooting is having assets to post to reduce risk. This is why companies might have a difficult time trying to obtain cash flow-based loans as they must ensure the working capital is allocated specifically for the loan. Certain businesses simply don’t have sufficient margin capacity to accomplish this.

Last, each type of loan utilizes different metrics to determine if it is qualified. For example, cash flow-based loans are more interested in EBITDA that strip away accounting impacts on income and concentrate on net cash availability. On the other hand the asset-based loans are not as concerned with income. Institutions will continue to be able to monitor liquidity and solvency, but have less requirements regarding operations.

Asset-Based Lending vs. Cash Flow-Based Lending

Asset-Based Lending

Based on the previous process of how a firm has previously made money

Use assets as collateral

Could be more accessible because there are usually fewer operating covenants

It is tracked using solvency and liquidity but not as focused on the future of operations

Cash Flow-Based Lending

Based on the prospective of the future of a business that is earning money

Make use of future operating cash flow to serve as collateral

May be more difficult to meet operating criteria

Tracked using profitability metrics that eliminate the impact of non-cash accounting on

Business Loan Options and Underwriting

Companies have a greater variety of borrowing options than people. In the ever-growing field of online financing, new types of loans and loan options are also being developed to provide new capital access products to all kinds of companies.

In general, underwriting for any kind of loan is heavily contingent on the borrower’s credit score and credit quality. Although a borrower’s credit score is typically a primary aspect in lending approval, each lender in the market has their own set of underwriting criteria for determining the credit quality of borrowers.

In general, unsecured loans of any type can be more difficult to obtain and usually have higher relative interest rates due to the possibility of default. Secured loans backed by any type of collateral may lower the risk of default for the underwriter , and thus, potentially result in better loan terms for the borrower. Asset-based and cash flow-based loans are two possible kinds of secured loans that a company can think about in determining the best available loan terms to lower the costs of credit.

Are Asset-Based Lending better than Cash Lending based on Flow?

The one type of finance isn’t always better than the other. One type of financing is more suitable for larger businesses that are able to provide collateral or operate with very low margins. The other option is suitable for businesses that don’t have assets (i.e. large service firms) but are confident in the future cash flow.

Why do lenders look at the flow of cash?

Creditors are interested in future cash flow as it is among the most reliable indicators of liquidity as well as being in a position to repay a loan. The projections for future cash flow are an indication of the risk; companies that have greater cash flow are more secure because they anticipate that they will have the resources to pay off debts as they are due.

What are the different types of Asset-Based Loans?

Companies often make pledges or use different kinds of collateral. This can include pending accounts receivables and inventory that is not sold manufacturing equipment, other long-term assets. Each of these groups will be classified with different amounts of risk (i.e. receivables may be uncollectable and land assets could decrease to a lesser extent).

The Bottom Line

When trying to obtain capital, companies often have many choices. Two such options are cash flow-based or asset-based financing. Companies with strong balance sheets and more assets in place may be more inclined to secure asset-based financing. In contrast, companies with higher potential and less collateral might be more suited to cash flow-based financing.