Cash flow financing is a form of financing in which a loan made to a company is backed by the company’s expected cash flows. Cash flow financing uses the generated cash flow as a means to pay back the loan. Cash flow financing helps Companies that generate cash from sales but don’t have a lot of assets to be used as collateral for a loan.
Cash Flow Loan vs. Asset-backed Loan
Cash flow financing is different from an asset-backed loan. Asset-based financing helps companies to borrow money, but the collateral for the loan is an asset on the balance sheet. Assets that are used as collateral might include equipment, inventory, machinery, land, or company vehicles.
The lender puts a lien on the assets that are used for collateral. If the company defaults on the loan—which means they don’t pay back the principal and interest payments—the lien allows the bank to legally seize the assets.
Cash flow financing works in a similar fashion in that the cash being generated is used as collateral for the loan. However, cash flow financing doesn’t use fixed assets or physical assets.
Companies that typically use asset-based financing are companies with a lot of fixed assets, such as manufacturers, while companies that use cash flow financing are typically companies that don’t have a lot of assets, such as service companies.