What is cash flow lending, and how does it differ from asset-based lending?

How lenders use it

A cash flow lender studies the earnings. It looks at several years of accounts, current management accounts, bank statements and forecasts. It tests ratios such as the debt service coverage ratio and total debt compared with EBITDA. Security may be light, though lenders often still take a debenture and a guarantee.

Cash flow loans usually come with covenants. These are promises the borrower must keep, such as a minimum coverage ratio or a maximum debt level. The lender tests them each period and acts if the borrower breaches them.

An asset-based lender works from a borrowing base. This is a list of eligible assets, each with an advance rate. The lender applies the rate and checks the assets often, with reports and sometimes field visits. The loan goes up and down with the assets.

Lenders often combine the two. A strong asset base with thin earnings suits asset-based lending. Strong earnings with few assets suit cash flow lending. A deal with both can have both tests.

Worked example

Example only. A distributor has EBITDA of £300,000, receivables of £400,000 and stock of £200,000. It already owes £250,000.

A cash flow lender caps total debt at 2.5 times EBITDA. That is £750,000, so new lending of up to £500,000. An asset-based lender uses 85% of receivables, £340,000, and 50% of stock, £100,000. The borrowing base is £440,000. The advance rates are made up.

Common confusions

Cash flow finance is also a loose label in the UK. Brokers use it for working capital loans, merchant advances and invoice finance. Cash flow lending, as lenders use it, means credit sized by earnings.

Cash flow lending is not unsecured lending. Many cash flow loans carry security. The point is how the lender sizes and repays the loan.

Asset-based lending is not the same as asset finance. Asset finance buys a specific asset, such as a van, with the asset as security. Asset-based lending is a revolving line against a pool of assets.

Questions lenders ask

What is the difference between cash flow lending and asset-based lending?

Cash flow lending is sized on earnings and repaid from them. Asset-based lending is sized on the value of assets such as receivables and stock, and the lender looks to those assets if the borrower fails.

What is a borrowing base?

It is the amount a borrower can draw under an asset-based facility. The lender takes the eligible assets, applies an advance rate to each and adds them up. The base changes as the assets change.

What do cash flow lenders look at?

Earnings history, margins, bank statements, current trading, debts and forecasts. They test ratios such as DSCR and debt compared with earnings and check that earnings are not boosted by one-off items.

Which suits a business better?

Businesses with steady earnings and few assets suit cash flow lending. Those with large receivables or stock and uneven earnings suit asset-based lending. The lender's credit policy makes the final call.

Debt service coverage ratio: Cash earned against loan payments due
Fixed charge coverage ratio: Cash left after costs against fixed payments
Invoice discounting: Borrowing against unpaid invoices, run by the business
Working capital loan: Short-term funding for day-to-day costs

This page is general information for lenders. It is not legal, tax or credit advice.