If any company is to remain competitive in times like this, then it must look for ways of sorting out the cash flow that will enable it to survive the harsh realities of today’s market. We shall be taking a look at the role that cash flow finance plays in the success of any business concern. So before knowing cash flow finance, one should know about what cash flow is. Cash flow is the difference of the cash at the beginning of the financial year and at the end of the financial year. Simply we can say that it is the difference of the opening balance and the closing balance of an organization.
What Is Cash Flow Finance?
The term under consideration refers to the situation whereby a loan made to a company is backed up by the company’s expected cash flow. It is quite different from asset-backed loans where the indices are based on the assets of the company. The schedule of loan repayment here is based on the projections of the company’s future cash flow. The cash flow loan can be long term or short term. The level of the EBITDA growth and margins; the manageable levels of the interest expenses is the focus of the debt covenant. Organizations often take this kind of loan when they want to make a big purchase or when the want to acquire a new business. The best thing about cash flow financing is that it allows organizations to obtain financing today, rather than near future.
Why Cash Flow Financing?
When a company is in need of any of the following:
- The desire to fund their operations
- When another company is to be acquired
- When there is a need to execute a major purchase
- To cover the gap of slow payments.
- To avoid any production interruptions
When a company is faced with any of the conditions above, then will naturally result in the need of cash flow finance. Companies take to this model to obtain need financing today rather than waiting for it in the future. The main reason why companies take to this is to ensure that they meet up with the demands of timely operational expenditures. So that operational activities of the business can run in a flow. Payroll requirements are one of such reasons why they are doing that. There are other benefits of taking cash flow finance. These benefits are if you want to purchase Fixed or current assets or are planning a business purchase, then it can free up the funds locked in your sales ledger. Also, one of the best things about cash flow financing is that you can separate your personal assets from of business.
Example of Cash Flow
Companies give another company an agreed amount of their receivables now which they will get back in the future. Let us bring it down home proper by giving practical examples of this concept. If Company X is in need of additional staffs to obtain a free-flow in their operation, then they have to employ the required number of staffs. Payment is to be made on the first of the month and the reliable stream of cash flow will not come in until the 18th of the month; then they have to resort to this model under review.
When they settled the wages on the 1st day of the month using the cash flow loan; they will settle the amount on the 18th of the month when their receivables come in. That is the practicality in the system.
Many companies are taking advantage of cash flow finance to meet their needs which have greatly impacted on their operation over a given period of time. This is a clever way of getting what you need at the right time and paying back the debt in the future.