Cash Flow Finance

What is cash flow finance?

Cash flow finance helps a business fund the gap between money going out and money coming in. Wages fall due on the 28th, but the customer pays on 60-day terms. Stock has to be bought in September for sales in December. A tax bill arrives in one lump while income arrives in dribs and drabs. Business cash flow finance exists to cover those gaps so that the business can keep trading normally until the money arrives.

It is a category rather than a single product. What the products share is a short horizon, a link to the business's trading cycle, and a cost that is usually higher per pound than long-term borrowing because the money is out for a short time and the lender carries more uncertainty.

The main types of cash flow finance

Revolving credit facility

A pre-agreed limit the business can draw on, repay and draw on again. Interest is charged on the drawn balance, often with a commitment or facility fee on the limit. It behaves like an overdraft but is usually provided by a non-bank lender and reviewed annually.

Business overdraft

An agreed borrowing limit on the business current account. Interest is charged daily on the overdrawn balance, with an arrangement fee. Overdrafts are repayable on demand, which means the bank can reduce or withdraw the limit at short notice. A business that is permanently overdrawn is using an overdraft as a term loan, usually at a higher cost; our business overdraft debt page covers that situation.

Invoice finance

An advance, typically 70% to 90% of the value of unpaid invoices, repaid when the customer pays. In factoring, the provider collects the invoices; in invoice discounting, the business collects and the arrangement is often confidential. Charges combine a service fee and a discount charge on funds advanced. Our invoice finance page covers the two forms in detail.

Merchant cash advance

A lump sum repaid through a fixed percentage of the business's card takings until an agreed total has been paid. The cost is set by a factor rate: an advance of £20,000 at a factor rate of 1.25 means £25,000 is repaid. A factor rate is not an APR, and the effective annual cost depends entirely on how quickly the takings repay it. Fast repayment means a high effective rate. Our merchant cash advance debt page explains the pitfalls.

Short-term business loan

A fixed sum over three to eighteen months, repaid monthly, weekly or sometimes daily. Interest may be quoted as a monthly rate or a total cost. Simple to understand, but the compressed term means each repayment is large relative to the amount borrowed.

How the cost structures differ

The products above charge in three different ways, and the differences matter more than the headline numbers.

Interest-based products cost less if repaid quickly. A factor-rate product costs the same total however quickly it is repaid, so repaying faster raises the effective rate. Fee-based products such as invoice finance cost more as turnover rises, even though the facility grows with the business. The only fair comparison is the total pounds paid for the money over the period it is actually needed. Our guide to comparing business finance offers shows how to do this.

Situations cash flow finance tends to suit

• Seasonal businesses that buy stock or take on staff ahead of a peak and can show from past years that the peak repays the outlay.
• Businesses with long debtor days, typically those selling to larger companies or the public sector on 60- or 90-day terms, where invoice finance matches the funding to the receivable.
• Growing businesses whose order book is outrunning their cash, because each new order has to be funded before it is paid for.
• One-off timing events such as a tax bill, a large supplier order or a contract mobilisation cost that the business can clearly repay from known income.

Situations it does not suit

Cash flow finance assumes the money is coming. Where it is not, the facility becomes a way of funding losses. A business that is loss-making month after month, that has no visibility of when customers will pay, or that is using one facility to repay another, has a profitability or debt problem rather than a timing problem. Adding a short-term facility in that position usually raises costs and shortens the runway. Our cash flow problems page helps distinguish the two, and the article on improving business cash flow covers steps that do not involve borrowing at all.

What cash flow finance costs

• Interest or discount charges on the amount drawn or advanced, often higher per annum than term lending.
• Facility, arrangement or service fees, charged on the limit, the advance or the turnover put through the facility.
• The factor rate on a merchant cash advance, which fixes the total repayable at the outset.
• Non-utilisation fees on some revolving facilities when the limit is not used.
• Renewal and review fees at each annual review.
• Personal guarantees, which are standard for unsecured facilities to limited companies and carry a cost in risk rather than money.

Benefits and drawbacks

Questions to ask before you agree a facility

• What is the total cost in pounds if I use the facility as I expect to over twelve months?
• Is the facility repayable on demand, and what notice would I get?
• How often are repayments collected, and what happens in a quiet week?
• Is a personal guarantee required, and is it capped?
• Does the agreement stop me taking other finance, and what counts as a breach?
• Can I repay early, and does that reduce the cost?

Cash flow finance and working capital finance

The two terms overlap and are often used interchangeably. The useful distinction is purpose. Cash flow finance addresses a timing gap: the money exists in the business's trading cycle but has not arrived yet. Working capital finance funds the operating needs themselves, such as stock, wages and supplier payments, and may be used to increase the level of trading rather than just smooth it. Many products, including revolving credit and invoice finance, serve both purposes, so the label matters less than the question of what the money is for and how it will be repaid.

Frequently asked questions