small business cash flow management

The Definitive Guide to Small Business Cash Flow

The Definitive Guide to Small Business Cash Flow

June 13, 2022

There’s a saying that goes, “Revenue is vanity, profit is sanity, but cash is king.” If cash is king, why then, do 82% of small businesses go broke due to cash flow issues

Viably’s December 2021 survey of small business owners found that:

  • 65% of business owners review revenue.
  • 68% of business owners review business expenses.
  • Only 45% of business owners review cash flow statements.

Many small business owners focus on revenue and profit but lack a clear understanding of the importance of cash flow to the long-term viability of their company.

We’ve written this guide to help small business owners better understand cash flow management and its impact on their decision-making. Below, you’ll learn why cash flow is so important, how to calculate and project it, how to improve cash flow, and how to avoid some common cash flow management mistakes that businesses make.

What is Cash Flow?

Small business owners must understand what the “flow” of cash means. Cash flow refers to the total amount of money flowing into and out of a business over time. Money that a small business receives is a cash inflow, while cash that leaves the business is a cash outflow.

Cash flow essentially boils down to sources of funds vs. uses of funds—the money coming into a business vs. the money going out. Cash inflows are derived from sources of funds. Sources of cash include revenue from product and service sales, loan proceeds, investment capital, and grant money. Uses of funds drive cash outflows and include materials purchases, operational expenses, salary payments, interest payments, asset purchases, and dividends paid.

The combination of sources and uses of funds at a given moment determines whether you have a surplus of cash that can be used for future operations and opportunities, or a deficit of cash, which means you are unable to operate without finding more cash.

3 Types of Cash Flows

For cash flow management and reporting, cash flows are divided into three types: operations, investments, and financing. Cash flows from operating activities occur as a result of business operations and daily operations, such as purchasing inventory or paying utilities. Investment cash flows are those related to long-term assets, such as equipment purchases or property sales. Financing cash flows result from debt and equity, including debt and interest payments to creditors and dividends paid to shareholders. Below are examples of different types of small business cash flows.

Operating Cash FlowsInvesting Cash FlowsFinancing Cash Flows
Revenues and royaltiesEquipment purchases/salesLoan proceeds/repayments
Salaries and commissions paidAcquisition of new business or product lineCredit card debt/repayment
Cash paid to suppliersProperty purchase/saleCapital lease payments
Income tax paid/refundedPurchase/sale of stocks/equityDividends paid/received
Rent and utilitiesOther fixed asset purchasesEmployee stock options/purchase

Cash Flow vs. Profit

Business owners often fall into the trap of believing that as long as they are showing a profit on their books, there will be enough cash to fund ongoing operations. Even profitable small businesses can run out of cash. Profit, like cash flow, is either negative (a net loss) or positive (a net profit), but that does not mean that cash flow and profit are the same. If a small business owner understands the relationship between cash and profit they can more easily make key decisions such as how to pursue new opportunities or how to adjust to changes in the market.

Even profitable small businesses can run out of cash.

Profit is a financial accounting term that refers to the balance left on the business books after operating expenses are subtracted from revenue. Profit is calculated using accrual accounting methods, which means that revenue and expenses are recognized on the books at a different time than the timing of cash flows related to those ledger items. In addition, profit calculations include “non-cash” expenses such as depreciation and write-offs.

Cash flow reflects the current reality of a small business’ bank account. It indicates the net flow of actual cash into and out of a business by accounting for all sources and uses of funds up to a point in time. Therefore, profit is just part of a company’s cash flow but does not tell the entire story.

For example, if a business sells a product to a customer who has 30 days to pay, the revenue from the sale and the cost to produce the product is recognized immediately on the profit and loss (income) statement. However, it may take 30 days on average (assuming the customer pays on time) for the cash inflow from the customer’s payment to appear in the business bank account, and the funds associated with the production of the product, such as materials and labor, have already left the business. Even though the business has booked a profit on the sale of that product, it has already spent the money to create it and has not yet received the cash for the sale.

As a result, you have a cash flow gap. Ongoing and increasing cash flow gaps are what cause small businesses to go broke.

RELATED: 16 Ways to Finance Your Small Business

Why is Cash Flow Important to Small Businesses?

Small businesses often have difficulty generating and holding onto the cash they need to fund continuous prolonged business operations. Many small businesses fail due to an ongoing lack of cash flow. To understand why cash flow management is so important to small businesses, it’s important to understand three financial concepts: liquidity, solvency, and viability.

A small business’ liquidity refers to its ability to meet its short-term financial obligations at any moment. Essentially, liquidity refers to the ability of a business to convert its assets to cash quickly. Cash is the most liquid asset, followed by short-term receivables. An illiquid asset would be equipment or a building.

Solvency refers to a state where assets (inventory, receivables, equipment, etc.) of the company are sufficient to cover its long-term liabilities (term loans, taxes, interest due, etc.). The cycle of cash inflows and outflows over time and the gap between the two determine a small business’ solvency. When a business’s assets become illiquid, it is unable to generate enough cash to meet its long-term financial obligations. Therefore, it may not be able to borrow or raise funds for future operations and obligations. This state eventually leads to insolvency. At that point, it is no longer a viable business.

Therefore, small business owners need to understand the liquidity of their business at all times. They should understand how many months of cash flow their business can easily generate before it runs out of cash and becomes insolvent. Good cash flow management allows you to run your business viably, that is to say, in a way that generates sufficient cash flows year after year.

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The Impact of Cash Flow on Small Business Operations and Growth

The timing of inflows of cash from sales and payments and outflows needed to meet financial obligations affect the small business’ ability to conduct daily activities. On any given day, a small business’s cash flow position determines whether it can pay its employees, pay its vendors, take on new orders, or offer its customers incentives and discounts. Cash flow ultimately affects a business owner’s ability to make key day-to-day decisions, plan for growth, and to react to market changes. 

To this effect, a small business’ growth trajectory is heavily impacted by its ability to generate cash and to have an accurate accounting of its cash position. Growth requires upfront cash to purchase fixed assets and materials or hire employees. A business owner may not be able to deliver on new orders and growing demand without sufficient current and future cash flows. Take seasonal businesses, for example.. A business owner can’t expand sales to meet seasonal demand without sufficient cash to finance the purchase of materials or inventory, and to pay for labor and additional production costs ahead of peak demand. If the business doesn’t have the cash, it won’t have enough product and cannot optimize sales during its greatest opportunity of the year.

Cash flow and growth present a conundrum in that a small business typically must demonstrate both growth and positive cash flow to appear creditworthy to a bank. Yet, the business may need bank funds to support business growth. Unless a company has enough cash flow to fund some growth on its own, it may be unable to secure additional funds from a lender to accelerate its growth. Further, if a business doesn’t have enough cash flow to cover current obligations, it won’t be able to obtain credit. Without access to credit, the business will have difficulty growing. Therefore, generating sufficient cash flow from daily operations and managing those cash flows well are critical to supporting future growth.

Cash flow determines the stability of a small business in the end. The cash flow of small businesses needs to be sufficient to cover everyday operations, handle unexpected expenses, fund growth opportunities, or adjust to other business irregularities. Without a sufficient buffer of cash, any of these factors could result in a cash flow gap.

How to Manage Cash Flow

How do you know how much cash you have at a given time? What about the cash you need to operate and grow your small business? Cash flow management involves tracking how much money is coming in and out of a business over time. Cash flow management tools and techniques enable business owners to predict and manage how much money will be available to the business in the future. Good cash flow management is key to success for small businesses.

Three cash flow management techniques help small business owners understand, manage, and improve business cash flows:

  1. Cash flow statement
  2. Cash budget 
  3. Cash flow analysis

We’ll cover all three in detail below, including how to prepare a cash flow statement, how to create a cash budget, and how to prepare a cash flow analysis.

How to Calculate Your Small Business Cash Flow

Before using any of the three cash flow management techniques, you need to know how cash flow is calculated. The most common method of calculating a small business’s cash flow breaks cash flow balances into the three categories and adds them to the cash balance at the beginning of the period. That formula for any time period is:

cash flow categories

In this formula operating cash flow (OCF) is the most important component. Cash flow from operating activities indicates how successful the day-to-day operations are by calculating how much cash is generated through normal business operations. OCF typically determines a business’s profitability and viability. Here is the formula for OCF:

OCF cash flow formula

The Cash Flow Statement

cash flow statementThe statement of cash flows is one of three financial statements that a small business must prepare at the end of each accounting period. The other two financial statements are the income (P&L) statement and the balance sheet. The cash flow statement is the single most valuable tool a small business owner has for managing liquidity and solvency over time.

The statement of cash flows breaks down small business cash flows into the three types mentioned above: operating, investing, and financing cash flows. It documents the money that flows into and out of the business, measures the changes in cash related to assets and liability accounts over a period, and calculates the business’s net cash position at any given point in time. 

The operating cash flow statement shows the increases and decreases in the current asset and current liability accounts over the period. Investment cash flows show the net cash generated from investing activities. Financing cash flows show the result of funding going into the business or the repayment of funding. A cash flow statement serves many valuable purposes. It helps identify any cash flow challenges and potential gaps between money coming in and money that needs to go out in the future. It can help business owners understand how to increase profit margins and can help identify costs that are negatively impacting the business. Additionally, the process of creating a cash flow statement might reveal funds that are unaccounted for, trends in different businesses or product areas, customer problems, or areas for future growth and investment.

How to Prepare a Cash Flow Statement (Two Options)

There are two methods available for preparing a small business cash flow statement: direct and indirect. The difference between the two methods is in how operating cash flow is derived. That said, net cash from operating activities and the final cash balance will be the same using either approach. Both methods have advantages and disadvantages. Regardless of which method you choose, you will need your income statement and balance sheet for the same period to calculate your cash flow position.

Direct Method

The direct method of producing a cash flow statement is based on cash accounting methods. Cash flow from the operations of a company is calculated based on actual cash inflows and outflows. Every single direct source and use of cash funds, such as cash paid by customers, cash paid to employees, interest paid, and so on, is listed on the cash flow statement using the direct method. Due to the level of detail this method of preparing a cash flow statement provides, the Financial Accounting Standards Board (FASB) recommends that companies use this method.

One of the main advantages of the direct method is that the cash flow statement can be read easily because it separates transactions into just two types: positive cash flow and negative cash flow. The level of detail provided is also helpful to investors and creditors in understanding the economics of the business, and it gives small business owners a precise view of where the company’s funds came from and how they were spent. The main disadvantage of using the direct method is that it takes time to prepare the cash flow statement in this way. Many small businesses don’t keep track of their cash in the detail required by the direct method.

Indirect Method

The general steps for the indirect method are:

  1. Start with net income before dividends for the period (e.g., a month).
  2. Add back non-cash expenses such as depreciation, amortization, and non-cash write-offs.
  3. Calculate changes in working capital (increase/decrease in current assets and current liabilities).
  4. Subtract fixed asset and other capital expenditures and add fixed assets sales proceeds.
  5. Subtract dividends paid, equity purchases, and debt repayment including interest, and add back long-term debt proceeds or capital investment.

Since most small businesses use accrual accounting and have a P&L and balance sheet to use, the indirect method is generally accepted as the easiest method of creating a cash flow statement because it is more quickly done than the direct method.

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Small Business Cash Flow Statement Examples

Although it may seem intimidating to some small business owners to calculate cash flow using either method, cash flow statements can be easily created using a basic spreadsheet template. Here is an example of the most commonly used method of calculating cash flow, the indirect method.

Indirect cash flow statement

Ledger ItemChange During the PeriodExplanation
Net Income before dividends$500,000Taken from the P&L statement
Adjustment for depreciation of fixed assets$15,000Depreciation is a non-cash expense deducted from net income.
(Increase)/decrease in current assets
(working capital)
An increase in current assets is a use of funds; a decrease is a source.
Accounts receivable decrease$25,000A decrease in receivables is a source of funds.
Inventory increase(225,000)An increase in inventory is a use of funds.
Prepaid expenses($25,000)Prepaying expenses such as rent and insurance is a use of funds.
Increase/(decrease) in current liabilitiesTaken from changes in balance sheet accounts
Increase in accounts payable$30,000An increase in payables is a source of funds.
Decrease in wages payable($35,000)Wages were paid out.
Other accrued expenses$2,000An increase in unpaid accruals is a source of funds.
Net Cash from Operating Activities$287,000CFO should be the same whether it is derived from the direct or indirect method.
Cash Flow from InvestingCash from the sale or purchase of property, plant, and equipment.
Equipment Purchase/Lease($25,000)This could include an outright purchase or capital lease payments on equipment.
Cash Flow from FinancingIncreases/(Decreases) in balance sheet liabilities
Line of Credit ($75,000)drawdown/(repayment)
Term loan $5,000Loan proceeds
Owner Draw($20,000)Sum paid out to owner in lieu of salary
Net Increase/(Decrease) in Cash172,000Sum of all operating, investing, and financing cash flows.
Beginning Cash Balance$80,000Add net change in cash to starting cash balance for the period.
Ending Cash Balance$252,000

Direct cash flow statement

Ledger ItemCash Paid/Received
During the Period
Cash receipts from customers$ 450,000total sales minus the increase in receivables, or plus a decrease in receivables
Less Cash Paid For:From cash records or calculated from P&L and balance sheet reports
Purchase of inventory and materials($80,000)cost of goods sold plus inventory increase/(decrease) plus account payable decrease/(increase)
Wages($10,200)wage expense from P&L, plus the decrease in wages payable, or minus increase in wages payable
Utilities and Rent($11,000)calculated similarly to salary expense
Advertising expenses($5000)calculated similarly to salary expense
Other operating expenses($32,000)calculated similarly to salary expense
Taxes ($90,000)calculated similarly to salary expense
Interest ($20,000)Interest paid on debt during current operating period
Cash flow from operating activities$201,800
Cash Flows from Investing Activities
Sale of machinery8,000Decrease in fixed assets on balance sheet plus gain recorded on income statement
Cash Flows from Financing Activities
Loan repayment($5,300)Decrease in long-term debt on the balance sheet
Net increase/(decrease) in cash$204,500
Cash Balance at Beginning of the Period$48,000
Cash Balance at End of Period$252,500

The Small Business Administration recommends using a 12 month cash flow statement using the direct method.

Small Business Cash Flow Projections

It’s not enough to create a cash flow statement and understand your current cash position. One reason so many small businesses run out of cash is that they do not forecast and budget for future cash needs. A cash flow projection is a forecasting tool that includes a breakdown of sources and uses of cash in a future period. Predicting changes in cash flow using the current cash flow statement as a basis allows business owners to anticipate changes in cash, make decisions, and budget accordingly.

As a rule of thumb, small businesses should create cash flow projections on a monthly rolling basis, forecasting 12 months out. To improve cash flow forecasting accuracy, projections should be updated weekly with actual sources and uses of funds. To create a cash flow projection, use your current cash flow as the starting basis. You can also use the prior year’s numbers for any given period (e.g., month) as a basis of cash flow for a future period. Adjust the basis for anticipated changes such as new products or services, price changes, employee changes, loan payoffs, and so forth, over time. Over the 12-month period, the cash flow projection should be updated to reflect developments in expenses and income. 

By conducting regular detailed cash flow projections the sustainability of operations can be planned for and executed in a way that maintains business stability and ensures that cash is available for controlled growth. In this regard, small business cash flow projections are one of the most important business planning tools to ensure business viability.

This can be a lot to manage for a business owner, especially if there are no trained financial professionals on staff. Consider a tool that can track and project cash flow in real-time, so this information is always at your disposal.

Cash Budgets

Another tool for small business cash flow management is a cash budget. One study of small business cash flow management found that 50% of small businesses had less than 15 days of cash buffer and only 40% had more than a three-week buffer. These statistics indicate that the majority of small businesses maintain a thin cash buffer. 

One way to improve the cash buffer is to create a monthly cash budget that relates to your cash flow projections and anticipates cash needs. By understanding projected cash flows, business owners can set aside the cash they will need for expenses and can manage business activities accordingly. As with cash projections, a cash budget should be created 6-12 months in advance and adjustments made as needed based on actuals.

In addition to being a cash flow management tool, cash budgets can serve as a small business management tool to explore and plan for future business scenarios. For example, a business owner could look at the impact on the budget of changing the speed of payment collections through invoice factoring or examine the impact of equipment leasing. This technique allows business owners to predict the outcome of a business decision or potential situation that impacts cash flow and plan accordingly.

One final benefit of creating cash budgets is increased accuracy. Few small businesses have very regular cash flow patterns. Over time, by comparing budgeted cash flows to actual cash flows a small business can improve cash flow forecasting techniques.

Cash Flow Analysis

Cash flow analysis is the third tool of small business cash flow management. This technique involves examining the components of a business that affect its cash flow, such as accounts receivable, inventory, accounts payable, and credit facilities. The purpose of cash flow analysis is to identify cash flow problems that impact liquidity and solvency and to help find ways to improve cash flow.

A cash flow analysis involves calculating several different ratios that provide insight into the reasons for positive or negative cash flows. These ratios are used to compare cash flow to other elements of a company’s financial statements.

The table below lists common ratios used and their formula, and provides a brief explanation of each ratio’s purpose.

Current Liability Coverage Ratiocash flow from operations – dividends (or owner draw)

÷ by average current liabilities

A measure of liquidity that indicates the ability of business operations to cover short-term debts. A ratio less than 1.0 indicates a business is experiencing a liquidity problem. The higher the ratio, the more liquid the business is.
Operating Cash Flow Ratiocash flow from operations

÷ by average current liabilities

Determines the amount of cash generated by basic business operations to ensure overall liquidity. A ratio of < 1.0 indicates a cash crisis.
Cash Flow Margin Ratiocash flow from operations ÷ salesIndicates how much cash is generated per dollar of sales and is generally a better indicator of financial health than gross margin.
Cash Interest Coverage Ratioearnings before interest and tax ÷ interest payments during the periodMeasures the business’s ability to meet interest payments on debt. If the ratio is < 1.0 the business cannot meet interest obligations.
Cash Flow Coverage Ratiocash flow from operations  ÷ (total debt + interest)Measures solvency and indicates whether a company can pay total debt obligations. A ratio < 1.0 indicates a danger of insolvency.
Debt to Asset Ratiototal liabilities ÷ total assetsA solvency ratio that measures the total amount of business assets that are funded by debt.

An owner of a business can gain insights into potential liquidity issues by performing a periodic cash flow analysis. A decreasing current liabilities coverage ratio, for example, indicates the business needs to focus more on receivables collection, discount inventory for a quick sale, or delay future inventory and materials purchases. In addition, by monitoring liquidity and solvency ratios it is easier to obtain funding from creditors who will do this type of analysis when deciding whether or not to offer credit facilities.

How to Improve Small Business Cash Flow

excess inventory can cause cash flow issuesSmall businesses often let inventory sit on shelves. A healthy cash flow depends on the turnover of inventory for which the cash outlay has already been incurred. Identify industry norms for inventory turnover and discount any inventory that exceeds that average or bundle with other products and services to move them off your balance sheet.

There are many ways to collect payments from customers more quickly. Utilizing technology that enables you to receive payments sooner, encouraging credit card payments, providing discounts and incentives for early payment, and ensuring that invoices are sent early, are accurate, and have clear deadlines are all strategies. Consider performing credit checks on potential customers or requiring deposits to reduce receivables write-off risk.

The relationship you have with vendors and suppliers is the most important factor in managing accounts payables. To generate credibility with vendors and reduce expenses, pay invoices on time and take advantage of early payment discounts. Try to negotiate better payment terms. For example, you might sign long-term contracts in exchange for lower prices.

If hiring a bookkeeper is too expensive, or even if you already have one, software that tracks receivables and payables, generates invoices, pays bills, and generates cash flow statements and other cash-related reports can enhance your small business cash flow management. Not only will technology save you time, but it will also save you money by providing you with the tools to better understand and manage cash flow.

A cash crunch is not the right time to learn what options you have to close the cash flow gap. Educate yourself on temporary funding options ahead of time. Consult your bank about solutions such as a revolving line of credit, and monitor your credit score so that you will have access to funding when you need it.

Consider flexible ways to finance long-term and capital-intensive assets such as equipment and facilities. Furthermore, depending on the market and the stability of your business, you may be better off purchasing real estate and making mortgage payments than being locked into a long-term lease.

Maintain a mentality that, as much as possible, your business should generate the operating cash flow it needs to cover its obligations over time. Imagine that debt is not an option and make cash decisions accordingly.

It is often difficult to identify routines and processes that inhibit cash flow in the day-to-day management of a small business. Technology is often the answer to increasing productivity. You should look for redundant and manual tasks that could be automated or eliminated to allow employees to focus on cash flow-generating tasks. An excellent example of this is empowering salespeople with data and technology to close deals more quickly and easily.

In the first year of a small business, owners may not know what to charge for their products or services, so the tendency is to keep prices low to ensure that customers come. Understand the true value of what you’re offering your customers. Benchmark against competitors and industry standards. Test the market and adjust prices as necessary. As an example, a coffee shop could raise the price of one or two high-demand products to see how that impacts sales.

Accepting credit card payments increases cash flow on the customer side. On the business payment side, you can utilize business credit card float time and cash-back or other rewards. Small business owners can also take advantage of early payment discounts with vendors by paying with a credit card.

Five Small Business Cash Management Pitfalls to Avoid

Despite the importance of having cash, having too much cash on hand can be detrimental to your small business, as ironic as that sounds. Recognizing and funding opportunities for re-investment and growth is essential, as well as utilizing cash efficiently so that it generates a profit. If the company does not grow or demonstrate productive uses of cash, access to capital may be limited and the business’ excess cash may be used up over time to maintain the business.

When small business owners expect rapid growth or see an increase in demand, they commit to cash expenditures such as hiring labor, purchasing raw materials and inventory, or spending on marketing without thinking about the timeline for product and sales revenue and subsequent cash flow. Delays or unexpected changes in demand could cause a cash crunch.

Some small business owners equate sales growth or revenue booked with cash flow sufficiency. Often, growing companies experience tight cash flow since they must hire more labor and produce more products before they can collect cash from sales. In many cases, there can be months between the cash outlay to ramp up production and the collection of product sales.

Even if your business qualifies for credit facilities or is attractive to investors, applying for loans and raising funds is a time-consuming process that can interfere with managing the business, especially in crisis situations. It’s much better to manage the funds your business has already generated or borrowed efficiently rather than constantly looking for additional funding.

Cash flow projections and management can be complicated. There are many small businesses whose owners are overburdened, preferring to focus on managing the day-to-day operations or developing the business instead of tracking cash flow and analyzing ratios. A CEO may be tempted to believe that monitoring and managing cash flow is the responsibility of an accountant or bookkeeper. Details can be left to these experts, but a poor understanding of cash flow will make it difficult to make good business decisions, and a lack of cash flow management skills could put the company at risk.

The Cash Flow Bottom Line

Small businesses need to manage cash flow strategically to survive and grow. The chances of a small business remaining viable dramatically increase when the business owner takes the time to understand, plan, and predict cash flows each month. Good cash management means small business owners are aware of their cash flows at all times and use cash flow tools to understand the current and future state of the business. A small business with strong cash management processes has many advantages. It can fund its operations effectively, acquire customers, negotiate optimal terms with vendors and creditors, and react strategically to market changes over the long-term. So the bottom line is: Don’t run out of cash, run viably!

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small business financing options

Small-Business Financing: Compare Funding Options in 2022

Small-Business Financing: Compare Funding Options in 2022

April 22, 2022

16 Ways to Finance Your Small Business

It’s no mystery that small businesses often need additional working capital to operate and grow, but financing your small business can be an intimidating and time-consuming proposition, especially for first-time entrepreneurs. While millions of small businesses in the U.S. use outside funding options (up to 70%), less than half (48%) percent receive the amount of financing they need. It’s no wonder only 55% of small business owners would recommend their lending partner to a peer.

What is Business Financing?

Business financing is a term used in reference to any way a business acquires capital (cash) to pay for operations, growth, or improve cash flow. In this guide, you’ll learn about all of the different options available to small business owners when it comes to funding those business expenses.

To grow and operate your business, you need cash, but where do you go to get it? What kinds of terms should you be looking for? It can be difficult to answer these questions, especially if you’re new to small business financing. It’s even more complex if you lack financial history or have poor credit.

The good news is that there are plenty of funding options for small businesses that fit a number of business profiles and needs, and new solutions seem to pop up all the time. Still, many business owners think they have only a couple of financing options—namely to borrow from a bank or to seek funding for a small business startup from investors. In reality, the right financing solution for your business depends on a number of factors, such as your business’s funding needs, your credit score and history, and other qualifying factors.

To simplify your financing decisions, we’ve outlined 16 small business financing options that range from traditional bank loans to lesser-known alternatives. Each option addresses different business needs and offers advantages and disadvantages, which are summarized below. This comprehensive list of small business funding solutions includes credit-based and equity-based options, as well as links to resources and examples of funding solutions.

Armed with this knowledge of your funding options, you can make the right decision for your small business.

Traditional Banking Options for Small Businesses

  • Branches and ATMs all over the country
  • Online banking and technology to facilitate transactions
  • Deep pockets
  • Geared toward large companies with extensive financial records
  • Require strong business (and personal) credit
  • Long, rigid process for small business funding
  • Often experience high turnover, impeding personal relationships
  • Often lower fees than national banks
  • Familiar with community needs
  • May consider character and impact on local community in small business lending process
  • Could connect small business owner with other local entrepreneurs
  • Fewer ATMs and branches, which could result in more fees
  • Products and services more limited
  • May not have the funds to support more expensive business initiatives
  • Limited experience with technology
  • Non-profit, so money may be passed on to customer through lower fees or interest rates
  • Higher chance of forming personal relationships
  • Sometimes offer free consulting services or financial assistance
  • Less lending capacity than larger banks
  • Limited technology which could lead to poor experience banking online
  • Fewer resources and more limited funding options
  • Faster approval rates than brick and mortar banks—sometimes 24 hours
  • Easy to compare rates
  • Manage loans and payments online
  • Fees and rates may be higher than other banks
  • Difficult to build personal relationships
  • Cannot manage accounts at a local branch

16 Financing Options for
Small Businesses

Traditional Bank Financing for Small Businesses

Small business lending through traditional banks is popular largely due to familiarity. You’ve likely worked with them as a consumer. You’re aware of how credit works and how to take out a loan. But before you choose a business lending option, you should know the differences between them and how they affect your credit, your time, your business, and your bottom line. Bank financing, regardless of which type of bank you use, is best for businesses or owners that have a good credit score, collateral assets, and a financial history of positive cash flow.

1. Term Loans

What is a term loan? In general, a term loan has a specific amount and a repayment schedule that lasts anywhere from one to 25 years. The interest rate on a small business term loan can be fixed or floating (changing). These loans are mostly used for capital-intensive spending, like buying equipment or a building, but they can also be used for ongoing expenses.

To secure a small business term loan, you’ll need to decide exactly what you’ll need the money for, how much you’ll need to borrow, how long you’ll need it. Before you apply for a term loan, you should gather your business and personal finances, check your credit score, and if applicable, create a business plan to prove you can pay back the loan. You might also need collateral to secure the loan, especially if you’re borrowing for over a year. Shop around to see what terms different banks are offering.


You can get some of the lowest interest rates and flexible repayment terms with term loans.


Borrowers must have very good credit and a solid business history and profitability in order to qualify for term loans. The application and approval process can take a few months. Additionally, due to bank policies, there may be penalties for early repayment of the loan or for not using the entire amount.

Bottom Line

Term loans are a viable option for small businesses who have good credit and a business history and who do not need immediate cash.

2. Revolving Line of Credit

Revolving lines of credit (LOCs) are flexible loans that, once approved, allow you to borrow up to the approved limits at any time. You can then borrow up to the credit limit again without having to go through another loan approval process once you repay some of the principal. You will pay interest on the amount you draw down. These credit facilities can be obtained via the traditional bank loan application process, through online banks, or the Small Business Association (SBA).


You can quickly and easily fund a temporary or seasonal uptick in cash needs with a small business line of credit. The line enables you to borrow flexibly to cover costs, such as increased inventory or longer payables terms, paying interest only. You can then repay the line quickly when your receivables are collected.


The lending bank often requires any balance on the line to be paid off by the end of each predetermined billing cycle. If the balance is not paid off, late fees and interest accrue against the unpaid balance, and are often very high. In many cases, collateral may be required to secure the line. The lender may also call the loan at any time, which can put your business at risk if you don’t have immediate cash to repay the balance.

Bottom Line

A revolving line of credit for small business is best when you need flexibility in borrowing from month to month to meet cash shortfalls and can repay the debt in a timely manner. As with term loans, you will need good credit and possibly collateral.

3. Commercial Mortgage

Commercial mortgages for small business are secured loans that finance new business property purchases such as a warehouse or office, or serve to refinance an existing business mortgage. These loans are usually secured against the property they fund. You can get a commercial mortgage from a bank or from a specialist lender. Banks usually offer better interest rates but are harder to secure mortgages from.


The main benefit of a commercial mortgage is to secure a property for your business that will increase in value. It will also save you on overhead such as rent (and rent increases), unfavorable lease terms, and potential business moving costs. As the owner of a property you may also generate cash flow by renting or subletting part of it. The interest on these loans is also tax-deductible.


The main challenge with commercial mortgages is the large upfront downpayment you will need to make to secure the loan and the arrangement fees of 1%-2%. Commercial mortgages usually require that your business has at least a three-year operating track record.

Bottom Line

If you need to secure a long term operating space, have the ability to fund a downpayment, and have been in business for a few years, commercial mortgages are a good option for mitigating future costs and risks.

4. Equipment Financing

These loans are used to fund the purchase or lease of commercial equipment, such as factory machines, office furniture, or special purpose equipment. As with other loans, you’ll need to make periodic payments that include interest and principal over a fixed term. The lender usually requires a lien against the equipment being financed.


Equipment financing for small business saves a large cash outlay when critical equipment fails or requires an upgrade. In many cases, it’s the easiest way to pay for equipment required to expand your business. As with other loans, rates and terms vary from strict (banks) to more flexible (online lenders).


Financing equipment will cost you more than paying cash outright. The lender may impose a lien upon some of your other business assets or require a personal guarantee. If you fail to repay your loan, the lender could repossess your business or personal assets.

Bottom Line

If you’re expecting to need some expensive or additional equipment and have decent credit but are short on cash, it makes sense to explore equipment financing for small business.

5. Overdraft Agreement

An overdraft agreement is a loan which allows you to have a negative balance on your bank account. You pay a fee for this service, interest on the overdraft amount, and you are required to repay the loan under the terms and conditions stipulated in the agreement.


This type of loan allows you to essentially borrow up to a certain limit without requiring any further discussion with the bank. It can bring peace of mind when unexpected expenses or cash shortfalls occur.


The bank may ask for security in the form of collateral and may also charge daily interest.

Bottom Line

While you don’t want to rely on an overdraft loan agreement for regular funding of your small business operations, it can provide a safety net for unforeseen cash shortfalls.

6. SBA Loans

As a small business owner, you’ve probably heard of Small Business Association (SBA) loans. These loans are geared towards supporting small businesses across the US. SBA loans reduce lending risk for issuing banks by guaranteeing a portion of your borrowings. You apply for an SBA loan through approved financial lenders—often a local bank or credit union.

SBA loans come in many varieties, ranging in size from thousands to millions of dollars, and they are available for a variety of small business financing needs. These include:

  • CDC/504 loans for financing fixed assets only up to $5.5 million
  • 7(a) loans that finance up to $5 million for most business purposes and work like long term bank loans
  • Microloans up to $50,000 for borrowers in underserved markets to cover a wide range of purposes.
  • Disaster loans offered during emergencies such as a declared federal economic disaster like the COVID-19 pandemic, typically funded directly by the SBA.

SBA loans can be a great solution for businesses who don’t qualify for a traditional bank loan. They're also more affordable because of their interest rate caps. Fixed asset loans are collateralized by the asset, so there's no need to commit personal assets. Additionally, the SBA offers a lot of free education and business information to small business owners.


Like bank loans, obtaining loan approval can be hard and takes a long time—usually at least two months. In order to get a larger loan, you’ll need collateral (usually personal assets) and a downpayment, so you need very high confidence that you can pay it back. If you have poor credit or limited financial history, it's unlikely you'll be approved.

Bottom Line

A small business loan is a good option if you didn't qualify for a traditional bank loan or want better terms, and if you have a solid business history and the time to invest in the process.

Non-Bank Loan Options

7. Community Development Loans

Community Development Finance Institutions (CDFIs) provide funding to small businesses and startups and are certified by the US Department of the Treasury’s CDFI Fund. They mostly focus on providing funds to businesses in underprivileged communities targeted by the federal government. There are four types of financial institutions in this category: CD banks, CD credit unions, CD loan funds, and CD venture capital funds.

To obtain a community development loan, you need to be able to demonstrate that you are part of the community they serve.


If you have a poor credit score and have an explanation, CDFIs will consider that and other circumstances when deciding whether to lend money. Usually, CDFIs do not require nearly as much collateral as banks do and offer reasonable interest rates. Additionally, some CDFIs offer local office space and on-the-ground business support, as well as a strong commitment to helping small businesses they fund to succeed.


Applicants must meet the requirements for the community that the CDFI serves, and still need to go through a typical credit application process and provide documentation. Since CDFIs coordinate funding from private sources, they may charge higher interest rates and fees than banks.

Bottom Line

You should consider CDFIs as an alternative to traditional financing if your credit scores are not great, you have little collateral, and you are part of an underserved, underfunded community.

8. Nonprofit Microloans

Nonprofit microloans are exactly what they sound like. These are small loans, usually from $5,000 to $100,000, that are offered to entrepreneurs and very small businesses who often don’t have collateral. They often cover basic operations and working capital to buy inventory, furniture, and supplies. Many nonprofit lenders target special interests, such as minority-owned businesses, specific industries, or underserved areas. Microloans are also available from government-sponsored agencies like the SBA and the USDA.


If you need a quick injection of cash or startup funds but have no collateral or poor credit history, microloans are a possibility. Additionally, these loans usually have a lower interest rate relative to your credit score and are funded faster.


These loans sometimes have restrictions on how you can spend the money. They may also have higher interest rates and shorter terms, typically one year. SBA microloans can take 2-3 months to process.

Bottom Line

If you need a small loan and are part of an underserved or special interest business community, it’s worth exploring microloans.

9. Business Credit Cards

Business credit cards can be issued by your bank or a credit card company. Business credit cards are different from personal credit cards, typically allowing for larger spending limits and providing more perks. They can be secured or unsecured.


There are numerous options for small business credit cards, and you can get more than one. Most business cards offer quick, easy, and convenient access to funding as well as rewards, cashback schemes, and interest-free terms of up to 90 days. As you pay off the balance, you can build your credit record, which can help you get more significant financing later. You or your employees can use credit cards for ordering supplies and paying business expenses quickly while tracking them and keeping them separate from personal spending.


Small business credit cards can tempt business owners to overspend. They can be liabilities if lost, stolen, or abused by employees, so it is important to have controls and limits in place. Credit cards are not scalable for larger financing needs because of their very high interest rates and spending limits. Additionally, you may experience a negative impact on your credit score if you make late payments or maintain large balances over a long period of time.

Bottom Line

Responsible use of small business credit cards can enhance your credit score, keep track of expenses, and improve cash flow while receiving perks, but they are not a scalable long-term financing solution.

10. Peer to Peer Lending

If you’re a relative newcomer to the small business financing scene, peer to peer lending (P2P) is filling a financing gap for small business owners. Online P2P marketplaces such as Lending Club and Prosper directly connect borrowers with non-institutional lenders. Your loan application is assessed in the same way as an application to a traditional bank. The P2P loan platform will use a credit reference agency to search for and analyze publicly available information. Combined with your financial history and credit rating, this data determines your lending risk profile and interest rate. If your application is accepted the service will match you with other individuals willing to offer you a peer-to-peer loan.


For many borrowers, P2P lending is a more accessible source of funding. Marketplaces offer both secured and unsecured loans. However, most of the loans in P2P lending are unsecured personal loans. Peer to peer lending for small business could come with lower interest rates because of the greater competition between lenders and lower origination fees.


Some states do not allow P2P lending or they require the companies that provide such services to comply with certain investment regulations. This means that some buyers cannot access these loans. P2P loans are often small and shorter term, so they might not cover all your funding needs. Despite the fact that business owners can get P2P loans for small businesses, these are technically personal loans that come with associated risks. Finally, there's no opportunity for borrowers and lenders to build a business relationship.

Bottom Line

P2P lending may fill a gap for business owners seeking small amounts of capital when existing options are not suitable or available. For non-traditional borrowers who don’t have established businesses or high credit scores, it’s worth investigating P2P loans.

11. Invoice Financing

Invoice financing is an income management tool that can make your cash flows more predictable and quicker to materialize. Through invoice financing, a third party provides a loan or a line of credit based on a proportion of your unpaid invoices. The loan amount is usually 80%-90% of the invoices outstanding in return for a fee plus interest. When your customer pays their invoice, you must pay back the loaned amount plus interest. In some cases the lender syncs with your accounts receivable system and collects their fees and interest before forwarding you the balance.


If you have invoices outstanding and need cash to fund operating expenses while you await payment, invoice financing frees up your cash flow that is tied up in receivables. This can be a good financing option for business owners who do not want to pledge personal collateral for a credit facility. Invoice financing is also generally cheaper than a bank loan and easier to obtain, making it an excellent choice for short-term needs. Best of all, invoice financing is fast.


You pay a fee of 1%-3% per month for the convenience and are still responsible for collecting payment from your customers. If they don’t pay, you still owe the amount loaned plus fees and interest.

Bottom Line

Invoice financing can be a great option for companies who have a lot of receivables, credit-worthy customers, and need cash immediately for operating expenses or growth opportunities. Explore invoice financing for small business especially if you cannot wait for other forms of financing.

12. Invoice Factoring

Invoice factoring is a similar concept to invoice financing. However in this case you sell some or all of your company’s unpaid invoices to a third party at a discount, typically 10%-20% of the invoice value. The factoring company then owns your invoices and is responsible for collecting payment directly from your customers. After the amount due has been paid in full by your customer, you receive the remaining invoice amount, minus a fee.


In addition to the pros listed for invoice financing, particularly if you have longer term outstandings, using invoice factoring will allow you to have more predictable cash flows and reduce your risk. The elimination of debt collection responsibilities can also save your company a lot of time and money.


It takes time to arrange factoring while waiting for the third party to validate invoices. Factoring is not suitable for companies with a few customers only because factoring companies want to spread their customer risk as widely as possible. These companies may also require long contracts of two years or more because of the risks involved. They also charge a higher fee than invoice financing due to the added risk of collecting from your customers. Factoring companies may also be perceived by customers as a sign that your business isn't doing well, and your customers may resent having to deal with a third party.

Bottom Line

Factoring can help your company when it has a lot of longer term outstanding invoices, you don’t have time or resources to chase down payments, and as a result your cash flow is suffering. Be careful to weigh these benefits with the impact on your customer relationships.

Equity-based Small Business Financing Options

13. Angel Investors

Angel investors provide capital for start-ups and small ventures. They are individuals with spare cash who are looking for higher returns than traditional investments would offer, usually 25% or more. Angel investors bridge the gap between small-scale financing provided by family and friends and venture capitalists. Angel investors usually receive a convertible note, which is short-term debt that has an interest or discount rate, a valuation cap, and maturity date. Investors can convert the note into preferred equity shares on a specific date or event.


Compared to a business loan, angel investor funding is less formal and more flexible. You won't have to do a lot of paperwork. These investors can step in and finance companies that banks might find too risky. Funding doesn't usually require monthly payments, which helps your cash flow. Many angels also provide guidance, support, and networking.


There are online resources to find angel investors, like AngelList and FundersClub, but obtaining angel investment is actually pretty difficult without personal contacts. The informal nature of angel investing can make negotiating terms complicated. Funding amounts are typically smaller than some bank loans, usually below $200,000.

Angel investors receive convertible debt at a premium, and then at the subsequent valuation of your business, they can convert that debt into equity. The more times you raise funds this way, the more equity and control of your company you lose. Angel investors expect companies to grow rapidly within three to five years so they can achieve the high returns they seek, so you will be pressured to do what it takes to continue growing your company.

Bottom Line

Whilte angel investors are a less obvious source of funding, it’s worth considering under certain circumstances, especially if your business presents a high risk/reward investment scenario or the opportunity for fast growth. There are many positives, including gaining expertise that can elevate your business and the potential to network to find future investors. However, you’re giving away equity in your company as well as some of your decision-making power.

14. Partner Financing

Partner financing occurs when another company in your industry, such as a supplier or distributor, funds your business growth in exchange for items such as product, distribution rights, proceeds from your company’s sale, or royalties. Partner financing is normally provided in the form of equity investment.


Most times, the company you partner with will be in your industry and can provide resources and expertise. Partner companies are usually larger and have access to a customer base, marketing programs, and other assets that your business can utilize. They also have a vested interest in the success of your business as an equity holder or royalty recipient.


If your business interests and goals are not aligned, partner financing can be challenging to manage. Royalties or distribution deals can be detrimental to your long term performance if not limited. If you or your strategic partner are unable to live up to your obligations, it could be detrimental to your business relationship.

Bottom Line

Partnership financing can be fruitful for your small business so long as the deal is structured as a win-win for both parties and your business interests are aligned.

15. Grants

Small business grants are essentially free money. Grants are offered by nonprofit organizations, government agencies, and corporations for many different reasons. Many of them focus on special interests and target groups, such as minorities, veterans, or women. The SBA, for example, grants funding to community organizations to promote entrepreneurship and businesses in certain industries. Grants are great sources of funds for startups in particular.


Free money is the best part. In general, if you qualify for one grant, your business probably qualifies for more. Some grant-giving organizations also offer advice and resources for your business.


Free doesn’t always come easy. You will have to do quite a bit of homework to research grants and their requirements. Grant applications can be very time consuming and because there is so much competition for grants, you may find they are not the best use of your time. Furthermore, most grants take several months to be distributed and require recipients to submit documentation and regular updates on how the funds have been spent and the results achieved.

Bottom Line

If you think your business may qualify for a grant, it’s worth putting some time into this funding option, as long as you are realistic about your chances of obtaining a grant and take a long term perspective.

16. Crowdfunding for Small Business

Small businesses can raise money online through crowdfunding by offering equity, rewards, or debt to investors. Many people think of crowdfunding as an option for startups, but established small businesses can raise funds online as well, especially if they manufacture or sell products, have a high growth business that can be easily expanded, or have an innovative technological solution.

Examples of crowdfunding platforms include Kickstarter, Indiegogo, Fundable, and SeedInvest.


Crowdfunding platforms offer low fees, a large audience of potential investors and customers, and allow for a variety of funding campaigns.


Crowdfunding loans for small businesses require a strong promotional strategy, transparency, and possibly giving up some equity in your business. There are many projects and businesses competing on each crowdfunding platform so it can be hard to get noticed. Some platforms can have high fees.

Bottom Line

Crowdfunding can be a great option if your small business needs to increase sales quickly, or if you need funding for product line expansion. You have to be organized to promote your business and possibly willing to give up equity.

The Bottom Line for Funding Your Small Business

A significant number of small businesses explore their options with bank banks when they need cash. But without a profitable business with a history and great credit, big banks may not be able to lend you the full amount, when you need it, and on the terms you need to run your business successfully. The good news is that there are a variety of financing options that you can choose from, some of which may be more suitable and easier to access than a traditional big bank loan. It’s worth taking the time to investigate some of these alternatives and identify new potential sources of financing to be better prepared for future financial decisions.

Better yet, take the time to research and establish relationships with banks and lenders that truly understand your business model and goals. There may be a better, faster, and smarter way to finance your small business than by filling out stacks of rigid applications.

For more tips on how to fund and grow your small business, check out the Viably blog.