Skip to content

Asset-Based Lending Vs Cash Flow Lending: Some Key Differences Explained

Any small business with aspirations to scale and expand its existing footprint relies on a healthy influx of capital. Most companies today need to borrow to achieve these ends and cover unexpected shortfalls. In such a case, one in which actual revenue earnings are considerably less than projected, quick access to short-term financing is crucial.

Short-term business loans help companies deal with a sharp economic downturn and unforeseen geopolitical events. These fast and convenient lending options let businesses continue making payroll and driving their strategic growth initiatives to ensure long-term stability.

As you start searching for short-term business financing, you’ll encounter two main loan products to address your fundamental needs. The first product is called an asset-based loan, and the second borrowing option is known as cash-flow lending. The primary difference between these two loan products is the path to approval or the qualification process.

Before deciding which loan is right for you and your current credit situation, understanding the difference between asset-based lending vs cash flow lending is vital. This article outlines these specific details on your behalf to help you make an educated decision about which loan is right for your business.

Asset and cash flow based lending: how do they differ?

You’ll need a solid working definition of each loan type described above before you can fully grasp their fundamental differences. Let’s start by exploring what each loan type entails and which core elements define these lending instruments.

What are cash flow loans?

Cash flow-based lending is an unsecured loan many small businesses use to cover their day-to-day operational expenses. Under most circumstances, cash-flow loans are used principally to finance working capital that covers your operating necessities. These could be items such as:

  • Payroll
  • Inventory
  • Lease payments
  • And more…

Once your business receives the incoming cash flow, the loan is then repaid, and this process repeats itself as required. Essentially, whenever you take out a cash flow loan, you’re borrowing against demonstrable future cash flows.

In other words, a representative at your preferred bank has analyzed your forecasted revenues and deemed them reliable enough to provide short-term financing on the basis of these figures. Even though the loan itself is formally unsecured, you’re still, in a sense, borrowing against future revenues. At the same time, these funds represent your ability to repay the loan.

As you conduct your search for short-term working capital loans, it’s worth pointing out that these lending instruments are drastically different than the loans you’ll encounter at a conventional retail bank.

The traditional loan types provided by the major financial institutions dealing in personal banking necessitate a fairly stringent analysis that looks for more than just a healthy stream of incoming cash flow. At traditional banks, loan officers and underwriters will conduct a more thorough analysis of your business’s finances in addition to reviewing your personal credit and payment history.

On the other hand, while alternative banks may want to examine your credit history, particularly your business credit history, before issuing a cash flow loan, your eligibility for these products is almost exclusively tied to your business’s ability to generate a reasonably predictable stream of future revenue.

What are asset-based loans?

Unlike cash flow loans, your eligibility and approval for an asset-based loan depend on the liquidation value of your company assets. This information is displayed on your balance sheets, and the banks write their loan products based on the estimated appraised value of your existing assets.

The most common examples of assets used as collateral in an asset-based loan are:

  • Real estate
  • Personal property
  • Equipment and machinery
  • Inventory
  • Accounts receivable
  • And other business assets

Asset-based loan products cater to companies that demonstrate a healthy balance sheet but either cannot or do not wish to borrow against future profits. Some larger enterprises occasionally leverage asset-based financing to meet short-term working capital needs, but this isn’t typical.

However, for the most part, this product is more common among small businesses that aim to grow, but their historic and forecasted revenues aren’t sufficient enough to warrant a cash flow-based loan product at the time of application.

Both loan products have their pros and cons. Before you agree to either one, conducting a careful analysis to determine which option between the two is more profitable is crucial.

Now, in the sections below, let’s take a more detailed look at the distinctions between asset-based lending and cash flow lending and explore which option might be better suited for meeting your business needs.

Collateral requirements

The upside to cash flow loans is that you don’t need to stake any of your hard assets as collateral. As mentioned, cash flow loans depend almost explicitly on your historically proven ability to drive future income.

While your forecasted revenue is important, most alternative lending institutions will likely want to see that you’ve maintained a positive credit rating -from both a business and personal perspective.

If your credit score is sub-par, this could be a determining factor that removes you from eligibility for a cash flow-based loan, even if you have the historical data to warrant an approval. In this case, business owners who need access to short-term financing will start exploring their options for an asset-based loan.

Since asset-based loans take into account the assets on your balance sheet and use them as collateral, this improves the prospects of a bank approval. Should you fail to pay the loan back, the loan is secured. The lender has the option of placing a lien on your assets, giving the bank a chance to resell your assets and recover the funds in the unlikely event that your business fails.

Loan compatibility

You may find yourself in a scenario demonstrating that you are well qualified for either an asset-based loan or a cash flow loan. In this situation, it’s really a matter of determining which loan product is right for your specific application.

Under most circumstances, your credit rating is a significant factor in determining how much money you can borrow at the outset. Cash flows are typically reserved for business owners with prime credit ratings, but surely not always. Business loan approvals, unlike retail lending products, are almost always case-by-case.

If, for some reason, you don’t qualify for an unsecured cash flow loan, the lender will look at your eligibility for an asset-based loan and establish whether or not it can serve your business profitably.

The key to obtaining an asset-based loan is that the value of your assets must be high enough for the lending institution to offset its own risk.

Lending Criteria

The business loan approval process varies from bank to bank, but in virtually every case, your eligibility is determined by the objective of your loan. The criterion used for qualifying you as a borrower is, therefore, distinct, and largely established by your earnings before interest, taxes, depreciation, and amortization or EBITDA.

EBITDA is the most common metric for analyzing creditworthiness on cash flow-based finance applications. Lenders will examine your earnings through this EBITDA in conjunction with a credit multiplier formula that evaluates changes in commercial banking deposits divided by changes in their reserves. The latter tool is used as an indicator of any potential risks that could arise during an economic downturn.

In short, if you have A-rated personal and business credit and well-documented historical revenue to support the proposed financing, a cash flow loan should be relatively simple to obtain. They won’t require you to put up collateral and largely staked in your personal track record as a borrower and business owner.

Small to medium-sized businesses will typically see out a cash flow loan after a significant shortfall. Events like these are most often attributable to unforeseen economic and geopolitical events, both of which have become more ostensibly frequent with time. If you don’t meet the qualifying criterion for cash flow-based financing, in that case, you would then start exploring your options for an asset-based loan.

Need help determining which loan product is right for your business?

If you believe you are qualified for either a cash flow- or asset-based loan, you’ll likely need to confer financial an experienced finance professional to determine which short-term lending option is best suited to meet your business needs.

While the objectives are usually the same, the focus and criteria for qualifying the two loans are substantially different. Moreover, the loan you select should be compatible with your current business applications and help your organization boost its revenue earnings.

New Merchant Capital caters to modern small businesses like yours that need quick funding to drive growth and bridge unexpected cash flow gaps. We offer various working capital solutions, including cash flow and asset-based financing to companies in various sectors, including the manufacturing, freight, restaurant, gas station, and staffing industries.

This list of businesses we serve, of course, is by no means exhaustive. No matter what industry you’re operating in, our experienced business lending professionals can help you continue driving growth and meeting your long-term objectives, even in the face of an unexpected shortfall.

Start exploring your short-term working capital finance options now by getting started online, or contact us by phone now at 844-228-0593.

Work With a Leading Commercial Lender

At NewBridge Capital Solutions, our loan products can help businesses of all sizes. With our exceptional customer service and reputable funding, we have become a trusted leader in the commercial finance industry. If you want to apply for a term loan that can provide working capital for your business, make sure to contact us.
Skip to content