Cash Flow Based Lending Helps Facilitate Access to Credit

Just like an automobile needs fuel to function, a business, irrespective of its size or nature, requires funds to carry out its daily activities. When compared to an individual, an organisation has several sources to borrow money. These loans are of two broad types – secured and unsecured loans. The funds lent by financial institutions fall under the secured category and come in different forms, each with its set of provisions. If you are looking at the secured loans segment then you can also opt for cash flow or asset-based loans as viable options. The former allows a company to borrow money based on their projected cash flows in the future. Whereas, the latter enables organisations to borrow funds based on the liquidation value of their assets mentioned in the balance sheet. 

The recent years have noted the growing consumer preference is in the favour of cash flow-based loans. Small businesses, especially, are turning away from conventional financial institutions and switching to such lending options. A survey from the Federal Reserve Bank of New York highlights a 39 per cent higher approval rate as compared to traditional banks is attributed as the primary driver of this change. New-age businesses also find comfort in these lenders as they focus on their future cash projections rather than their current investments. Moreover, such companies need instant loans to support their cash flow needs, and these lenders meet their demands within a matter of hours; instead of days or weeks. 

Cash-Flow Vs Asset-Based Lending

To understand the difference between the two, let’s take a deeper look at their functions and prerequisites. Under the purview of cash-flow lending, a financial institution issues the loan after considering the past and future cash flows of the borrower. In this form of lending, the credit rating of the organisation plays a crucial role at the time of approval. Lenders even evaluate the value of the enterprise before granting the loan. The most striking feature of this method is that it requires no collateral. Hence, recipients can get access to instant financing. Such loans are best suited for both young startups and SMEs that maintain high margins on their balance sheet or don’t have enough hard assets to offer as collateral.

On the other hand, in asset-based lending, a borrower obtains funds by offering inventory, accounts receivable, or other balance sheet assets as collateral. Some common assets that are offered as collateral include real estate, land, properties, company inventory, equipment, machinery, vehicles, or physical commodities. This form of lending benefits companies with large balance sheets and lower EBITDA margins. However, these loans have several guidelines for the collateral status of the asset. For instance, usually, one particular asset cannot be used for receiving multiple loans. 

The flexibility brought by cash flow lending systems not only supports the needs of small-scale entrepreneurs but also benefits those who engage in seasonal occupations, like fishing and horticulture for survival. As compared to the conventional monthly EMIs charged by banks, the cash flow system provides financial institutions with the freedom to customise loans in a manner that these individuals and businesses only pay the interest during the months their business is functioning. In the offseason, they are exempted from such payments. 

RBI Initiatives 

The Reserve Bank of India has shown immense support towards this new mode of cash flow based lending systems. It has brought in several regulations and guidelines to boost the credit availing capacity of business owners across industries. For instance, it has focused on the promotion of credit bureaus and proposed a Public Credit Registry (PCR) framework to improve both cash flow and the credit culture in the country. In an effort to encourage digital cash flow lending, it has also launched projects to make at least one district of a state or union territory 100 per cent digitally-abled by the end of March 2021. 42 districts are an active part of this initiative. It aims to address the demand side constraints by providing customer protection along with sustainable credit as well as investment products. 

Bearing these details in mind, we come to the final question – should there be a more considerate attempt to encourage cash-flow-based lending? Yes, such lending mechanisms are the need of the hour. Availability of credit and cost of credit need to be based more on cash flow-based lending, instead of collateral security, for improving the credit to Gross Domestic Product (GDP) ratio. The various credit bureaus and the proposed Public Credit Registry (PCR) framework will play a pivotal role in bettering the credit flow across the nation as well as will transform the entire lending atmosphere in India.

The author is Co-Founder & MD, Kissht

DISCLAIMER: Views expressed are the author’s own, and Outlook Money does not necessarily subscribe to them. Outlook Money shall not be responsible for any damage caused to any person/organisation directly or indirectly.