Asset-Based Lending vs. Cash Flow-Based Lending

Understand the differences and increase your awareness of available financing options.

‎ ‎ ‎ ‎ ‎ ‎ There are a lot of debt financing options. Asset-based versus cash flow-based financing is one way to break down the solution landscape. By understanding the differences between these two types of financing, companies can increase their awareness of what’s available and make more informed capital decisions.

Same Question, Different Expectations

‎ ‎ ‎ ‎ ‎ ‎ “How likely am I to get my money back?” is the fundamental question lenders evaluate before loaning your company money. Asset-based and cash flow-based lenders have different expectations for how they’ll be repaid and what they look to for comfort (collateral).

‎ ‎ ‎ ‎ ‎ ‎ Asset-based lenders expect to be repaid from your company turning assets into cash (e.g., collecting on receivables, selling inventory, etc.) – or in a worst-case scenario, seizing and liquidating the assets.

‎ ‎ ‎ ‎ ‎ ‎ Cash flow-based lenders expect to be repaid from your company’s future profits – or in a worst-case scenario, proceeds from a forced sale of the business.

Asset-Based vs. Cash Flow-Based Loans

‎ ‎ ‎ ‎ ‎ ‎ What borrowed money is used for is relevant. There is often a linkage between what is being financed and how the lender looks at potential repayment.

Calculating Borrowing Capacity

‎ ‎ ‎ ‎ ‎ ‎ How much money your company can borrow is based on the lender’s source of repayment / collateral.

‎ ‎ ‎ ‎ ‎ ‎ Both lender groups establish what they could collect in a worst-case liquidation or forced sale and determine a comfortable loan-to-collateral value (LTV) ratio.

‎ ‎ ‎ ‎ ‎ ‎ Liquidation values are derived from appraisals and comparable market transactions. However, determining a comfortable LTV ratio is more art than science. While there are generally accepted caps / limits, the lender’s assessment of collateral quality dictates how much additional cushion is needed to gain comfort.

Ability to Combine

‎ ‎ ‎ ‎ ‎ ‎ In the event of a liquidation, asset-based and cash flow-based lenders share proceeds and, as a result, consider the combined loan-to-collateral value ratio.

‎ ‎ ‎ ‎ ‎ ‎ For certain businesses, asset and business value are intertwined, limiting the capacity to combine financing solutions. For example, a limousine service company with vehicle loans will have limited cash flow borrowing capacity due to the implications of a liquidation – if the vehicle loan provider repossesses and sells the limos, the remaining business value / ability for cash flow lenders to recoup their loan would be significantly impacted.

Which Should My Company Be Using?

‎ ‎ ‎ ‎ ‎ ‎ There is no one-size-fits-all solution. Consider:

Availability of options (varies based on market conditions and company growth stage – e.g., cash flow capacity is limited for earlier-stage businesses with shorter operating history)
Capacity to meet future financing needs
Ability to meet loan requirements (costs, repayment schedule, covenants / reporting, etc.)

‎ ‎ ‎ ‎ ‎ ‎ Companies can make more informed capital decisions by understanding the differences between asset-based and cash flow-based debt. Download our simple tool to calculate your company’s borrowing capacity.

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