Working Capital
Working capital loans provide short-term funding to cover expenses without needing collateral up front.
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What is a working capital loan?
A working capital loan is a loan that business owners take out to pay for everyday business expenses. The name refers to how you use the money rather than the specific type of loan.
Your working capital is the money that you spend on short-term business expenses, such as your payroll, inventory, software subscriptions, and utilities. On your balance sheet, your working capital equals your current assets minus your current liabilities.
Small business owners may consider different types of small business funding if they need additional working capital. For example, both an unsecured business loan and a line of credit could give you additional cash, and there are pros and cons to either option.
Both can be helpful to help ensure your business has enough working capital on hand, which is vital to keep your business running. Fall short, and you might not have enough funds to pay your employees or purchase the supplies you need to deliver your products and services.
Even if your business is running smoothly, a lack of working capital can result in lost opportunities—imagine having to turn down a large contract because you can't afford the upfront costs. Successful seasonal and cyclical businesses may also take out working capital loans to help cover expenses during slow periods to bridge the gap between their slow and busy seasons.
What are the types of working capital loans?
Working capital funding can include a wide variety of loans, lines of credit and alternative types of financing. But common types of working capital financing include:
Working capital line of credit
A business line of credit is an extension of credit that allows—but doesn't require—you to take out a loan. Once you apply and get approved, you will have credit available to you, (which generally has an approved credit limit) against which you can borrow.
Business lines of credit may also be revolving, which is similar to how credit cards work. You may be able to borrow against your credit line, pay down the debt and then borrow again without having to reapply or open a new account.
While business lines of credit can offer flexibility, some may have variable interest rates, which could lead to higher costs. Some accounts also have maintenance fees, which you pay to keep your account open, and draw fees on each loan you take. Though, it's becoming more common that these fees may be waived or altogether removed, it’s important to understand the terms of the funding and find the solution that best fits your business.
SBA loans
Approved financial institutions offer Small Business Administration (SBA) loans, which are partially guaranteed by the SBA. Because of the arrangement, SBA loans often have some of the most favorable terms for small business owners.
However, qualifying for an SBA loan can have its challenges, and both your personal and business credit scores and finances could impact the decision. It also may take several months to complete the application and approval process, which means an SBA loan might not help if you need working capital fast.
Invoice factoring
Invoice factoring is when you sell your outstanding invoices to a factoring company. For example, if you have an outstanding invoice for $10,000 that's due in 60 days, you might be able to sell the invoice and receive 75 percent of the amount ($7,500 upfront). Once your client pays the factoring company, the lender will forward you the remainder of the unpaid invoice minus its fee.
The arrangement can help businesses that are struggling with cash flow and that sell to other businesses. But it may not be a good fit for a business that sells directly to consumers, as it probably won't have many outstanding invoices. Additionally, depending on the arrangement, you may have to factor and pay a fee on all your invoices, even if you don't want to factor each one. Be clear on the terms and conditions of the agreement as you could be on the hook to repay the lender if your client doesn't pay their invoice.
Merchant cash advances
A merchant cash advance (MCA) is another type of alternative financing that some business owners use for working capital. With an MCA, you can quickly take out a loan based on your business's sales. You'll then repay the loan with a portion of your daily or weekly revenue.
While MCAs can offer fast funding, they often charge high fees and may offer a repayment schedule that could leave you with a cash flow crunch. You also may need to accept cards or online payments to qualify, as MCA providers will often automatically take a portion of these payments. However, there are some alternatives that use automatic withdrawals from your business bank account instead.
How to use a working capital loan
Depending on your needs, you can use the proceeds from a working capital loan to help run or grow your business.
- Smooth cash flow: If you're struggling with affording your bills because the due dates don't align with when your business gets paid, a working capital loan or line of credit could help you avoid these stressful ups and downs.
- Prepare for a new client or large project: Starting a large project can require upfront expenses if you need to buy supplies, pay contractors or hire new staff. However, you might not see the proceeds from your hard work for months.
- Cover expenses during the off season: If you know there's a slow season approaching, you may want to apply for a working capital loan or line of credit early to ensure you have enough funds to make it to the next busy season.
- Pay for an emergency expense: While you don't know when an emergency will strike, you can plan and be prepared. Know your options and which might be best for your business.
What are the benefits of a working capital loan?
The main benefit of a working capital loan is it gives you the money you need to keep your business running or to invest in and grow your business. But depending on the type of financing, a working capital loan could offer you several additional benefits.
- Use the funds how you want: While you might have a specific expense or project in mind, lenders might not place many restrictions on how you use the funds. If you have money left over, you could look for other ways to invest in your business or repay part of the loan early to save on interest.
- Collateral is not always required: There are unsecured small business loans and lines of credit that you can use for working capital without needing, or risking, collateral.
- Maintain ownership of your business: Unlike with equity financing, you won't have to sell shares in your company to take out a small business loan or line of credit.
How to get working capital funding
The specific steps you'll take to get a working capital loan will depend on the type of funding. An MCA might be straightforward and take less than a day for approval, while an SBA loan could be more rigorous and take several months. Many small business loans will fall somewhere in the middle. And online lenders may offer a straightforward and fast application, approval and funding process.
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