Asset-Based vs. Cash Flow-Based: 4 Major Differences
The difference between a small business asset-based loan and a traditional bank loan is centered around how the lender views the insuring of their loans. Usually, banks look at the financing first then collateral. Since they only require cash flow as the primary source of paying the loan, they usually require more financial covenant than collateral control and monitoring. Asset-based loans on the other hand zero in on the collateral first and cash-flow second.
What is Cash-Based Lending?
With cash-based lending, the terms of your loan primarily depend on the financial health of your company. Cash-based loans let you borrow additional working capital based on your future cash flow – your revenue and profit margins.
To qualify for this type of financing, you need to demonstrate that you will have more than enough cash available to repay the loan. The loan amount you qualify for will depend on your capacity to pay back the money you borrowed.
Lenders will check your credit rating and management information to determine your creditworthiness. They will assess your repayment terms based on your cash flow.
Asset-rich companies may benefit more by applying for an asset-based loan since lenders do not focus on future cash flow predictions. Moreover, asset-based loans tend to be more flexible than bank loans making them ideal for a majority of borrowers.
What is Asset-Based Lending?
On the other hand, asset-based loans allow you to free up working capital tied to your company assets by using it as collateral to secure a loan. Assets like stock, equipment and machinery, real estate, and invoices can be used to acquire additional funds.
Lenders decide on the terms of the loan based on the liquidation value of your assets. Generally, it focuses on a company’s current assets. Some of the collateral used to secure an asset-based loan include the following:
- Accounts Receivable
- Purchase Orders
- Machinery and Equipment
- Commercial Real Estate
- Marketable Securities
- Intellectual Property
The Differences Between Cash-Based and Asset-Based Financing
Now that you know the definition of cash-based and asset-based loans, here’s how they differ from one another:
Asset-based lenders look at the various assets of a borrower and focus on the kinds of collateral that a borrower can guarantee. The essential assets lenders consider in an asset-based loan application include the income received from real estate, equipment, inventory, as well as customer invoices.
The borrower is also obliged to deem the lender’s company as the party who has rights of seizure over the assets and collateral should the borrower default on their payment obligations. Cash-flow based loans don’t need collateral, but instead, they depend on the company’s income and credit rating.
A lender’s focus when considering an asset-based or cash-flow loan is considerably different. For instance, a traditional bank loan is based primarily on a business’ cash flow, while in the case of an asset-based loan, the company’s assets are the primary focus followed by cash flow.
Small Business Asset-based Loans vs. Cash-flow Assessment
For small businesses that are not generating enough cash-flow in the short term, an asset-based loan can be the ideal funding option. However, the downside of this is that an asset-based loan can cost you more than a cash-flow based loan. This can be attributed to the fact that asset-based loans usually come with more expensive fees, as well as higher interest rates.
Business loans do not come in a one-size-fits-all solution. For instance, with a cash-flow based loan, lenders consider the company’s credit rating first before deciding on whether or not they qualify for funding. Simply put, cash-flow based loans are more appropriate for businesses with a larger and more stable cash-flow in addition to an excellent credit rating. To qualify for an asset-based loan, the borrower’s assets should be considered adequate enough for the lender to deem the risk acceptable.
How to Determine What’s Best for Your Business
Which is the better option for your business? The answer to this question largely depends on what you have and what you need. The type of loan you choose should be tailored to your company’s specific needs.
It’s normal to have second thoughts when deciding on the type of loan which is best for your business. Whether you decide on the small business asset-based loan or apply for a cash-flow based loan, it’s best to talk to a financial expert. Lending experts can walk you through the entire application process, evaluate your business, and discuss the pros and cons of both financing options.