Cash-Flow Financing
A type of loan that allows a company to borrow money on its expected future cash flows. In the business world, this type of loan takes the place of the kind of deal that on the street might get your arm broken if you didn't pay it back fast enough. Still, while you'll likely keep your arm, you might still lose the shirt off our back.
The problem often is the cost of these loans are very high, with giant interest rates and often additional fees involved as well. Cash flow financing is different from traditional business borrowing whereby company’s assets secure the loan. Rather than having set payments, this type of borrowing has payments that are typically based on a percentage of receivable payments. For some more risky loan programs, the settlement or payment is structured as a percentage of daily credit card settlements and can even be required on a daily basis.
Because of the varying nature of required payments, this type of financing is often only used on a temporary basis and only when it is the only option available and before you put the proverbial, “business is temporarily closed for remodeling” sign up on your storefront while you contemplate moving back in with your parents...
Related or Semi-related Video
Finance: What is the Times Covered Inter...23 Views
finance a la shmoop- what is the times covered interest ratio?
okay people. we'll just restate the question if it's simpler. from your [girl frowns in classroom]
operating profits this part of your income statement right here- how many
times is your interest expense covered? still not simple enough? okay how about
this? how big a multiple is your operating
profit of your interest cost? there we set it boom. okay so you run furry nation [definitions listed]
America's finest purveyor of animal bodysuits. the company has two billion
dollars in debt on which you pay six percent interest or 120 million dollars
a year. you really wanted that platinum encrusted fidgets spinner and well you
just couldn't wait. furry nation has revenues of three billion dollars and [hand spins fidget spinner]
conveniently has operating profits of 360 million. so how many times larger is
your operating profit than your yearly interest? well check out the hundred
twenty million dollars error of interest from before, that number gets divided
into the operating profit number. and the answer? three. well why does this ratio [equations]
matter? well the three times interest covered number is a solid indication of
how easily you can pay the interest if not the principle of the debt you have
borrowed. think about a normal boom and bust business cycle. in a bad year your [bridge blows up]
company might shrink to have only two billion of revenues and 180 million
dollars of operating profits. in which case in that dismal year it would have
only one point five times interest coverage. in a great year with say 900
million of operating profit while the coverage ratio would be 6x or 600 [equations]
percent or six times. now put your butt in the seat of the lender. if you're the
one who loaned the two billion dollars at 6% while you're getting pretty
nervous about being able to collect your money back when operating profits are
down to just one point five times. but it's six times interest well you sleep [woman snores in bed]
like a baby happy to keep collecting your interest payment though. so why do
we use operating profits this line here instead of net income or after-tax
profits this line here when we calculate the times interest ratio? well because
interest costs are tax-deductible? they're a cost just like [definitions]
plastic or office building rent or mandatory company yoga retreats. the cost
of renting money is treated for tax purposes really no different from the
cost of renting a building. so we don't worry about taxes when we're focused on
just repaying our debts. just don't try to use that excuse when tax time comes [woman smiles behind desk]
around though. Uncle Sam well he don't play.
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