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Your business is on the verge of hitting a critical growth stage, and you need financing to push it to the next level. However, you’re presented with a fork in the road: asset-based lending vs cash flow lending—which one should you choose?
The right type of financing depends on what your business can leverage to secure that funding. Before discussing the ideal choice for your business, let’s uncover the differences between asset-based business loans and cash flow lending so you can decide which financial solution is best for you.
Asset-based lending (ABL) is a type of financing where a business borrows money that’s backed by collateral such as real estate, equipment, product inventory, accounts receivable, or others.
ABL allows companies to leverage their existing assets to fund essential business functions, whether it be production costs, business development, or other purposes. With that said, asset-based lending comes with some unique features.
Asset-based lending is ideal for businesses with significant assets, but who struggle with a limited or reduced cash flow. Industries where inventory and accounts receivable tend to be large, such as manufacturing, wholesale, and retail sectors, benefit most from asset-backed business loans. However, any business with an extensive product stock can potentially benefit from ABL.
Read more: Empower Your Business: Knowing Your Financial Rights in Borrowing
Contrary to an asset-based loan, cash flow lending provides financing for a company’s projected cash flow, not its current assets. Generally, a cash flow-based loan is unsecured or partially secured, focusing on the borrower’s potential to generate sufficient revenue to repay their debts.
Cash flow lending is well-suited for businesses that produce strong, consistent revenue streams despite limited tangible assets. Companies that benefit most from cash flow based lending tend to be service-based, such as tech startups.
When considering asset-based lending vs cash flow lending, you can look at it this way: the former considers what a business “owns,” while the latter considers what a business “earns.” This difference influences how the loan is structured and the requirements for the borrower.
Asset-based business loans require a company to have tangible assets. To qualify for these loans, the value of the collateral should equal or slightly exceed the total amount of the loan. The type of collateral required varies, depending on the lender’s policies, as well as the business’ creditworthiness and more.
On the other hand, business cash flow loans focus on a company’s potential to generate future revenue. Collateral is not a requirement. As long as the business can demonstrate efficient cash flow management, high growth, and revenue potential, there’s a high likelihood it’ll qualify for a business cash flow loan.
Asset-based lending usually carries less risk for lenders since they’re backed by collateral. They offer conservative loan-to-value ratios, which create a buffer against asset depreciation and can yield larger loan amounts for suitable businesses. As traditional bank loans, they’re also easier to secure, assuming the company has noteworthy assets.
Cash flow based financing carries more risk for lenders because it’s contingent on how much the company earns, not any tangible assets. With that said, cash flow lending is generally more accessible to borrowers because it doesn’t require physical collateral. That translates into a faster approval process and is ideal for fast-growing companies that can repay debts with their steady revenue streams.
Asset-based lending usually offers lower interest rates since they’re lower risk (being tied to collateral). If the business defaults on the loan, collateral assets can be liquidated to recover the lender’s investments.
With cash flow based financing, interest rates are typically higher because of the greater risk posed to lenders (being tied to projected cash flow). The long-term cost of a cash flow loan may then be higher, and it’s not uncommon for them to have shorter repayment terms, which further increases borrowing costs. With that said, these costs can be offset by the company’s revenue if it’s steady.
Asset-based lending is often more scalable, especially as the business continues to acquire tangible assets. They can secure more financing with more collateral backing it up. Additionally, companies can leverage a mix of assets such as real estate, inventory, and accounts receivable to increase borrowing capacity.
Cash flow based lending is more flexible because the loan can be adapted to the company’s revenue and growth in its current state. Loan payments can be adjusted to accommodate seasonal fluctuations or abrupt changes in cash flow patterns. They’re also highly suitable for growth initiatives such as investing in new projects or exploring new markets.
Deciding between asset-based lending vs cash flow lending boils down to a simple question: Do you have more assets or cash flow?
If your business has the hard assets to secure a loan, then asset-based loans might be your bread and butter. However, if your company has robust and predictable cash flow without many assets, a cash flow loan will likely be the better option.
However, the choice is not always cut-and-dry. Aside from factors such as your industry history and credit score, other considerations such as your current business stage, financial strategy, and your need for working capital also determine what loan agreement is most suitable for you.
Asset-based lending and cash flow lending are neither superior nor inferior to one another. One may be a better fit for your business, depending on your specific needs. But if you’d rather not rely on traditional loans to get funding, consider invoice factoring from trusted firms like REV Capital.
As an award-winning financing firm, we help your business meet growing demands without having to borrow funds. Our funding solution gives you immediate access to the money you're owed for services you’ve already provided, turning your outstanding invoices into working capital for a small fee.
Contact us today to learn more about invoice factoring and see if it’s better for your business than cash flow vs asset-based lending. Get funded today.
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