Cash-Flow Loans: How to Know If They're Right for Your Business

Getting a cash-flow loan isn't always a problem, but getting the right one can be. Experts explain what you may want to do before getting this type of loan.
September 08, 2017

In 2014, shortly after Joanna Douglas started her cleaning business, she decided she should look into cash-flow loans.

Douglas says it was pretty clear that her business—Clean Affinity Cleaning Service, a Portland, Oregon-based cleaning service that specializes in green cleaning—needed some sort of infusion of money. Clients were taking longer than she expected to pay for her services.

"We planned to use the money for payroll, payroll taxes and random business expenses," Douglas explains. "Most important though was payroll. We had to make payroll, regardless of whether or not our clients were 30 or 60 days late on a payment."

Unfortunately for her, the cash-flow loan she ended up taking out just made her financial problems worse. The payments, she says, were much too high.

Many cash-flow loans do exactly what they're supposed to—solve a cash crunch. But sometimes cash-flow loans can create cash problems, too.

So if you're thinking of looking into cash-flow lending, you may want to do several things first.

1. Research the loan before applying for it—and compare them to other cash-flow loans.

There are all sorts of cash-flow loan options. You could go to your local bank or credit union. You might look into automated clearing house, or ACH loans. ACH loans let the business owner use projected earnings as a form of collateral. There are online lending firms that more or less do a cash advance, which can be expensive.

Factoring, similar to ACH loans, is yet another option that some businesses employ; the business owner is advanced most of the money that will be coming from an invoice. When the invoice comes, what was advanced goes back to the lender—plus a little extra, of course.

Before you follow through on any of these options, make sure you do your research and take stock of your ability to pay back the loan.

Make sure to run your absolute worst-case scenario through your loan structure to understand if that structure really works for you.

—Heidi Pozzo, founder, Pozzo Consulting

Douglas heard an ad on the radio advertising a short-term business loan from a well-known online company, and decided to go for it. She filled out an online application in minutes, and within 48 hours, her bank account was flooded with $12,000.

“I read all of the fine print," Douglas says now. “But I was overeager and figured I could pay it back quickly."

It wasn't as easy as she had anticipated. Every month, thanks to that $12,000 loan, $1,220 was automatically withdrawn from her bank account. Douglas later did some serious number crunching and concluded that she was paying approximately 40 percent APR—and when the loan was finished over a year later, she had paid almost $15,000 for the $12,000 loan.

In other words, while her employees cleaned, the loan almost cleaned her clock.

Of course, not all cash-flow loans have punishing terms, and Douglas doesn't regret taking out a loan. She regrets that she took out this particular loan.

2. Look for alternatives to cash-flow loans.

Again, there's nothing wrong with taking out a loan if the terms are desirable. But you might be able to get cash-flow lending without having to borrow from a lender, says Al Zdenek, president, CEO and founder of Traust Sollus Wealth Management, based out of Princeton, New Jersey. Zdenek is also the author of Master Your Cash Flow.

Zdenek suggests asking a key supplier for a loan.

Many will lend you money on a temporary or longer-term basis," he says. "I just advised a business to do this to buyout a partner, but it can be used for cash flow also."

You could also borrow money from a client. While that may sound horrifying to some, it all depends on the nature of the relationship.

“My firm floated our own note issue some years ago—interest only-payable in 10 years, unsecured. You will probably pay a higher interest rate than market interest, but there's no hassle with banks and no fees," Zdenek says.

He also suggests seeing if you can stretch out some of your own payables to 90 or 120 days.

“It isn't a loan, but it can be a smart way to increase your cash flow," he says.

Another option? Offering discounts to clients who pay their receivables faster. 

“Again, not a loan, but it can bring in a lot of cash earlier," Zdenek says.

3. Try to find the cash you need within your business.

If you're having a cash-flow problem, it's probably too late to cut back on expenses—especially if you're trying to meet payroll.

Still, if you can see you're going to have a cash crunch in, say, a couple months, you may want to see if there's a way to bring down your costs, says Heidi Pozzo, a Portland, Oregon-based business consultant and founder of Pozzo Consulting.

“Inventory levels, collecting accounts receivable—those are easy places to find cash," Pozzo says.

If there isn't time, and you have to apply for cash-flow lending or else, still look for cash within your business. Getting the cash you need from your business can help you pay off the loan more easily.

“I find the best companies are maximizing the cash flows and margins in their business, and reducing working capital needs. They have a handle on the business, and qualify for better loan structures and use them for growth, not daily operations," Pozzo says. “The least expensive source of cash is typically within the business."

4. Look at worst-case scenarios for paying off the loan.

Let's say things go south, and you're stuck paying off the loan. What would that mean for your business? Figuring out the answer to that could be a smart business move.

“Make sure to run your absolute worst-case scenario through your loan structure to understand if that structure really works for you," Pozzo says.

As bad as the loan that Douglas took out was, it could have been worse. For instance, there are loans that give the lender the right to convert the loan to equity if you don't pay them back fast enough. At least she didn't wind up giving a lender equity into her company.

In fact, Zdenek cautions, “stay away from loans that give any rights to buy equity or that will cost you equity."

He also says that you'd do well to stay away from loans that accelerate payment or terminate if you have a bad period of business. He also cautions against going with hefty loans that require an annual audit or review by a CPA firm—that can be a costly expense on top of paying everything back.

In Douglas's case, everything worked out in the end. To make sure she had enough money coming in for her payroll, other expenses and to pay off the loan, she worked hard to find more households in need of cleaning.

"We hustled in order to pay this loan while continuing to grow our business. No secret sauce—just hard work, references and more hard work," Douglas says.

There was a bright side to having to hustle: The loan eventually left, but the new clients didn't. In fact, her business has grown enough that she now has 30 employees.

But Douglas still has this to say to fellow business owners who are looking for cash-flow loans: “Don't fall victim to crazy rates like I did. Avoid them at all cost. Honestly, it's predatory lending at 40 percent… I wish I would have done more research and not jumped at the first quick, easy loan."

Read more articles on loans.

Photo: Getty Images