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Intro To Working Capital Loans
Most small business owners need extra working capital at some point. A host of unforeseen circumstances can cause revenue to dry up or compromise the majority of operational funding. Common examples include bad weather, changes in demand, or even a fire in the business next door. The inevitability of these events resulted in the popularization of Working Capital Loans. While other products are geared towards long-term investments or massive expenses, a working capital loan is designed to help businesses recover from temporary cash flow issues and take advantage of new opportunities.
If you don’t need a lot of money but need more than a little, working capital loans could be the exact solution you’re looking for.
In this guide, we’ll answer the following questions and more:
What Are Working Capital Loans?
Before diving into an explanation of working capital loans, it’s important to understand working capital basics.
Working capital refers to the money needed to cover everyday operating expenses in your business. These are the day-to-day costs of keeping your business running. Typical expenses covered by working capital include payroll and rent.
A working capital loan gives businesses the cash they need to cover these ongoing, everyday operational costs. A working capital loan can come in various forms, including a short-term working capital loan, merchant cash advance on credit card sales, invoice factoring agreement (on unpaid invoices due), a special SBA loan, or even a business credit line.
A working capital loan may also be known as operating capital or cash flow loans.
Why You Need Working Capital for Your Business
In a perfect world, working capital comes from the cash flowing into your business due to sales of your service or product. However, not all businesses enjoy a smooth cash flow all the time. Your business could just be starting out and slowly increasing your customer base. Or maybe you operate a seasonal business. In this case, you might have less cash on hand during your off-season. A lack of working capital makes it tough to keep up with bills you must pay each month – bills that are due whether your business is booming or not.
When your business lacks working capital, you need to tap into a different cash injection source. That is where a working capital loan product can come into play.
How Do Working Capital Loans Work?
Though a working capital business loan can come in many forms, each version has a few things in common. Unlike a more traditional bank loan, even the best working capital loans can be accessed by small business owners with subpar personal credit and less than one year in operation. You don’t need collateral or even a personal guarantee. Due to these loose requirements and the shorter terms, interest rates tend to run on the higher side.
Since working capital loans are more accessible through online lenders, companies don’t have to specify how they plan to use the money. Some online lenders like Kabbage Funding offer multiple types of funding products. Thus, they would recommend the repayment terms that make the most sense for your cash flow and the problem at hand. For example, a Merchant Cash Advance might be best for a highly seasonal business that’s looking to cover operational expenses during the slow season. On the other hand, business Lines of Credit might be best for a company that’s looking to bridge a much shorter gap in cash flow. For standard short term loans, terms can be as little as just four or five months. Other types of working capital loans can have terms as long as several years.
Also, your borrowing amount isn’t just the sum of your monthly business expenses. It must additionally account for your current/short term liabilities or what your business owes in the near future (loans, accounts payable, taxes, etc.). To run your business, the borrowing amount must exceed your short-term liabilities.
Working Capital Loans – Research, Facts & Reports
According to the Voice of Small Business in America 2019 Insights Report, the most common use of new funding for small businesses was to improve cash flow. 54% of respondents borrowed money to help smooth their cash flow gaps or apply to working capital.
The Fed’s 2019 Small Business Credit Survey estimates that the small business financing market is about $1.4 trillion in size.
In 2019, the Small Business Credit Survey also found that medium- and high-credit-risk applicants seeking loans or line of credit financing were almost as likely to apply through an online lender as they were to complete an application with a traditional large bank (54% and 50%, respectively). However, only 41% were likely to apply for credit through a small bank.
Also in In 2019, the SBA reports that they approved 100,495 loans totaling $32.7 billion. The SBA does offer working capital loan programs as well, even some tied to any real estate owned.
What Are The Advantages of Working Capital Loans?
Working capital loans are incredibly accessible and can be approved in as little as 24 hours. You don’t need an excellent credit score, collateral, or more than six months in operation.
This is because working capital loans are designed primarily for businesses that are dealing with unforeseen circumstances. Products with a long term, higher borrowing limits, and lower rates tend to have long application processes. Business owners must also take time to figure out exactly how much funding they need. On the other hand, with working capital loans, most small business owners are just looking for enough money to cover their operational expenses and other short-term business liabilities. When a business owner can easily calculate their desired funding amount, the application process goes much quicker.
Another advantage is the availability of multiple repayment structures. With the help of your small business lender, you can choose the repayment structure that most effectively solves the dilemma you’re facing. And though working capital loans are frequently used to fill cash shortages and pay short-term debts, they can also be used for growth-related investments like ordering inventory or taking on a larger, costly project.
Other types of small business loans aren’t as versatile. They can only be used for a few purposes. For example, you wouldn’t take out a Term Loan or SBA Loan to cover operational expenses.
What Are The Disadvantages of Working Capital Loans?
Loose requirements place a heightened degree of risk on small business lenders. In other words, business owners with poor credit, cash flow problems, and less than one year in operation are less likely to pay off the loan on time. Thus, lenders offset this risk by assigning higher interest rates and shorter terms. That’s why you should only explore working capital loans if you’re dealing with a temporary issue. If your cash flow doesn’t recover, a high interest rate could put your small business in jeopardy.
Working capital loans also generally come with lower borrowing amounts than Business Term Loans and SBA Loans. For this reason, you can’t use a working capital loan for expensive initiatives like developing a new product, renovating your physical space, adding a new division, etc. Remember, working capital loans work best for short-term needs instead of long term investments that may take years to produce results.
- Get access to funds quickly
- Unsecured loan programs available
- Less than perfect credit accepted
- Use for a variety of purposes
- Higher rates & fees than with traditional loans
- Might require collateral
- It gets more expensive with lower credit
Working Capital Loans Compared To Other Products
|LOAN TYPES||MAX AMOUNTS||RATES||SPEED|
|Merchant Cash Advance||$5k – $1m||Starting at 1.09||1-2 business days|
|SBA Loan||$50k-$10m||Starting at 3.75%||3-5 weeks|
|Business Term Loan||$10k to $5m||Starting at 5%||1-3 business days|
|Business Lines of Credit||$1k to $450k||Starting at 1% p/mo||1-3 business days|
|Receivables/Invoice Factoring||$10k-$10m||Starting at 1% p/mo||1-2 weeks|
|Equipment Financing||Up to $5m per piece||Starting at 3.5%||3-10 business days|
|Revenue Based Business Loans||$10K – $5m||Starting at 1% p/mo||1-3 business days|
Who Qualifies For Working Capital Loans?
Approved businesses generally met the following criteria:
How To Apply For Working Capital Loans:
The application process may be slightly longer or shorter for different types of loans. However, all variations require very little paperwork, and you can get funded in just a few business days. Here’s how to get started:
Step 1: Choose Your Loan
We usually recommend the loan options that feature the most uncomplicated repayment terms for your cash flow. This depends on the length of your cash flow gap and how quickly you’ll be able to pay off the loan.
Step 2: Gather Your Documents
This step depends on the type of loan options you’re applying for. Here are the documents and information you may need to get started for each option:
- Voided business check
- Bank statements (3 Months)
- Drivers license
Step 3: Fill Out Application
You can begin the application process by calling us or filling out our one-page online application. Either way, you’ll be asked to enter the information from the previous section along with your desired funding amount.
Step 4: Speak to a Representative
Once you apply, a representative will reach out to you to explain the repayment terms, rates, and terms of your available options. This way, you won’t have to worry about any surprises or hidden fees from lenders during repayment.
Step 5: Receive Approval
For most loan products, it only takes a few days for credit approval. Depending on the type of loan, funds should appear in your bank account anywhere from 1-3 business days for most funding options.
Your Working Capital Loan Gets Set Up – Now What?
Your loan isn’t just a way to get financing for your business. It’s also an excellent opportunity to start building (or improving) your credit.
Regardless of the type of business loan your company gets, make all of your required payments on time and in full. If you get a business credit line or another form of revolving credit like business credit cards, keep your balance below the credit limit.
Consistently making your business financing payments on time and in full will positively impact your credit. And that means preferred rates and terms when you next need business financing.
What If I’m Declined For a Working Capital Loan?
If your application gets declined, it might be due to poor personal credit or the conclusion that your company cannot afford to take on more debt at this time. In this case, we might recommend alternative tools for financing your business, like a business credit card or even a personal loan. Both options are much easier to qualify for than business loans.
We might also recommend credit repair services, which focus on raising your personal credit score by identifying and eliminating the issues that are keeping it down.
People Also Ask:
When Is a Working Capital Loan a Good Idea?
This product makes sense for short-term needs or cash flow gaps that last no longer than a few months. In addition to covering expenses during a rough patch, common functions include ordering inventory, paying short-term debts, or taking on expensive projects that would otherwise compromise operational funding.
If you’re looking to finance a long-term investment, you might consider a Business Term Loan or SBA Loan instead.
How Do You Calculate The Working Capital of a Business?
To calculate your business’s net working capital, see the calculation below. The numbers that make up both parts of the equation should appear on your most recent balance sheet.
Current Assets = What your business owns (Cash, Inventory, Accounts Receivable, etc.)
Current Liabilities = What your business owes (Bills, Payroll, Loans, Accounts Payable, etc.)
Net Working Capital = Current Assets – Current Liabilities
Your current assets must exceed your current liabilities to meet short term business obligations. , if you intend to grow your business, you should make sure to increase the gap between what your company owns and what your business owes.
The net working capital formula will produce an amount in dollars. Sometimes, though, looking at this number won’t immediately tell you if you have healthy working capital. Due to individual factors like industry or company size, which seems like healthy working capital for one business could represent the bare minimum for other companies.
The answer to your working capital ratio, on the other hand, leaves no room for uncertainty. While the net working capital formula subtracts assets from liabilities, the working capital ratio formula divides them.
Current Assets / Current Liabilities = Working Capital Ratio
What Is a Good Working Capital Ratio?
A ratio between 1.2 and 2.0 usually indicates a healthy operating capital level. If your ratio is less than one, you may face liquidity problems in the near future. A ratio higher than two, however, might suggest insufficient spending or too much unused operating capital. Maybe you’ve neglected to invest enough profits back into the company or failed to spend enough money to generate growth.
What Do Businesses Use Working Capital Loans For?
You might use your working capital funding for any of the following things:
- Creating a cash flow cushion
- Meeting business growth needs
- Sales & marketing costs
- Website updates
Of course, you can use your working capital loan for other reasons that will help your business.
Can You Use a Working Capital Loan For Hiring?
Many seasonal businesses like retailers use working capital loans to hire extra staff for the busy season. Rather than waiting until the last minute, retailers can hire several weeks or months before the busy season begins. This gives the new hires plenty of time to learn the ropes and prepare themselves for the upcoming surge in demand. If training is particularly vital in your industry, companies might consider using your loan to invest in a formal onboarding program. When you don’t have to worry about covering operational expenses, your company can focus less on productivity and more on educating new hires about company culture, customer service, etc.
Can I Get a Working Capital Loan with Bad Credit?
Yes, a business owner can access all types of working capital loans with bad credit. However, it’s important to remember that credit score plays a different role in different products. For example, your borrowing amount for a Merchant Cash Advance is based almost entirely on your monthly debit and credit card sales. Likewise, your credit score has hardly any impact on the accessibility of Accounts Receivable Factoring.
For a short-term working capital loan, on the other hand, your credit rating is indeed factored into your borrowing amount, along with your rates and terms.