Working capital loans can satisfy immediate business funding needs
Small business financing can be useful in different situations, and borrowers can choose from several loan options. One type of funding you may consider for short-term needs is a working capital loan.
A working capital loan is designed to help with day-to-day business operations or unplanned expenses your regular cash flow doesn’t cover. Business owners may use a working capital loan to fund payroll, to pay rent or utilities, to service debt payments, to support insurance premiums, to purchase inventory, to compensate suppliers, or to make tax payments.
“Working capital loans are best used for daily operations to keep your business afloat until more revenue comes in the door,” says Cortlon Cofield, certified public accountant and owner of Cofield Advisors in the greater Chicago area.
Cofield says working capital loans can be a helpful option for businesses that routinely experience seasonal downturns. “For example, if your business is usually slow in the winter but picks up in spring, then a working capital loan could be a great funding source to keep your business operating until sales ramp up,” he says.
Types of Working Capital Loans
More than one kind of business financing falls under the working capital umbrella. Figuring out which type of working capital loan to choose may depend largely on the purpose of the funding.
Types of working capital financing include:
- Lines of credit
- Cash credit or bank overdraft lines
- Trade or vendor credit
- Merchant cash advances
- Term loans, including short-term loans
- Invoice factoring
Each type of working capital financing functions slightly differently. With cash credit or bank overdraft, for instance, the bank allows business owners to withdraw more money they than have on deposit. This source of working capital can help business owners avoid situations where a check drawn on their account is returned for insufficient funds.
A merchant cash advance, on the other hand, allows business owners to tap working capital by drawing against the future value of their credit card receipts. It’s not technically a loan but a way to get working capital quickly, with less stringent qualification requirements compared with traditional bank loans. A factor rate determines how much the borrower will owe in interest. Rather than paying an annual percentage rate, or APR, borrowers pay a factor fee ranging from 1.14 to 1.18. This fee is multiplied by the amount of the advance to determine the total amount that must be repaid.
The common thread between different types of working capital financing is how helpful they can be to small businesses.
“Working capital loans give you quick and convenient access to funds for day-to-day or unexpected needs,” says Katherine Li, director of product marketing at business lender BlueVine.
In addition to those needs, working capital financing can allow business owners to take advantage of revenue-boosting opportunities as they come along. For example, you may need to purchase products from your supplier quickly to fill a large order.
[Read: Best Unsecured Business Loans.]
“You may come across a customer who needs your service or product immediately,” Li says. “Some small businesses are forced to say no because they don’t have the funds to meet the demand, but that wouldn’t be a problem if you have a working capital loan.”
Where to Find Working Capital Loans for Small Businesses
Two broad options are available for working capital loans: traditional banks and online lenders.
Banks may offer small-business loans, and some are backed by the U.S. Small Business Administration. The SBA itself doesn’t grant loans; instead, SBA partner banks provide them. The SBA’s 7(a) loan program allows qualified businesses to borrow up to $5 million in working capital.
Bank loans may offer competitive rates and more traditional loan options, such as fixed-rate term loans. However, going online for a working capital loan could mean fewer headaches.
“From my experience with clients, working capital is easier to obtain through online lenders versus traditional banks,” Cofield says. “This is because traditional banks follow more strict guidelines and regulations than online lenders.”
Startups, for instance, may have a harder time getting working capital through a bank. Lenders generally want to see that business owners have a history of generating revenue and profits. That’s much harder to do with a business that has yet to open its doors or that has only been operating for a few months.
Online lending typically offers fast approvals and delivery of funds. “That’s because most of the online lenders use advanced artificial intelligence and machine learning technology that makes the application and approval process faster and more accurate,” Li says.
Working Capital Loans vs. Other Types of Small Business Financing
While working capital can help businesses keep the doors open and operations running smoothly, other financing options may provide smarter solutions.
If you need funds for specific uses, a more customized loan type may be a better fit. For example, if you’re starting a new franchise location, you could look into franchise financing. Secured loans that use what you’re purchasing with the funds as collateral may offer lower interest rates than working capital options such as an unsecured line of credit.
Customized loan products can be tailored to your operation’s exact financial needs. For instance, you could use a commercial real estate loan to purchase a location for your business, or a business construction loan could help you make improvements to your workspace. An equipment loan secured by the equipment itself could offer a lower rate than an unsecured line of credit.
Is a Working Capital Loan the Right Business Financing Move?
Working capital loans could give you the funds you need to start your business or to keep it running smoothly. They can be more flexible than other types of loans, allowing you to use the money for multiple types of expenses, unlike loans designated for a specific purpose, such as equipment loans.
Working capital financing also may allow you to maintain full equity in your business if these funds will avoid the need for investors. And when you make on-time payments, you could build your business credit score.
Ultimately, determining whether working capital is the right choice for your business requires considering not only how the financing will be used but also the bigger cost picture. It all comes down to doing the proper research before borrowing.
“Take time to shop around and check out different options when it comes to working capital loans,” Li says. “Pay close attention to the total costs of the financing you’re considering.”