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10 min read. July, 2022 – by Amanda D’Auria
What is a working capital loan, and how can businesses use it to their advantage? Discover more in this article!
Most businesses experience periods of low revenue at least once during the year. Whether it’s due to seasonal demand changes or the weather, these businesses need to plan accordingly to cover their day-to-day costs, pay their employees, and, most importantly, stay ahead of their competition.
One way that business owners can combat this issue is through working capital loans, which are financing options designed for short-term issues. But, for someone unfamiliar with this type of financing, it can be challenging to understand what you’re getting yourself into, especially if this is your first time considering a loan for your business.
If you’ve been asking yourself, “What is a working capital loan?” you won’t have to wonder for much longer. Read on below for everything you need to know about getting a working capital loan for your small business.
Working capital loans are short-term financing options used to cover a business’s daily operation expenses, including payroll, rent, and outstanding debt obligations. While you can’t use a working capital loan for long-term investments or to purchase lifelong assets, they’re perfect for a business that deals with cyclical or seasonal sales, as they can help you manage cash flow during periods of low business activity/sales.
For example, many manufacturing companies produce a majority of their products during Q3 to prepare for the holiday rush of Q4.
They know that they’ll have the revenue to cover their operational expenses after the end of the year, so they might take a working capital loan before Q3 to ensure they have enough capital to produce their products and pay their employees during the high production months.
Working capital loans’ repayment terms are generally shorter than other financing options. Typically, you’ll have to repay the amount borrowed within 6 to 18 months, so it’s best not to take on any large expenditure, such as an aggressive expansion of your business.
Now that we’ve briefly answered the question “What is a working capital loan?”, let’s add some more depth to the definition by breaking the term down into its different types:
A short-term working capital loan is a lump sum payment given to a business for operational expenses. You’ll have to repay the borrowed amount within the terms you agreed upon with your lender.
If you end up needing more capital than you originally borrowed, you can potentially secure another working capital loan in addition to the original, but your lender might require you to pay off the existing loan entirely beforehand.
Unlike a loan, a business line of credit is revolving credit that a business can draw from whenever they need additional capital. You only pay interest on the amount you draw, and this option typically carries higher credit amounts and lower interest rates compared to a business credit card.
However, it’s often expensive to begin a business line of credit, and some lenders may require you to pay fees during your term. You should find a lender that offers transparent guidelines for the best results with your business line of credit.
SBA Loans: SBA loans, otherwise known as Small Business Administration loans, are financing options where the government agrees to cover a portion of your outstanding balance in case you default on the loan.
Lenders will typically offer lower interest rates for SBA loans, as the government backing acts as an extra layer of security. SBA loans are a much broader type of financing option. Rather than limit yourself to operational expenses, you can use an SBA loan for other business expenses, such as purchasing real estate or assisting with a long-term asset purchase.
There are a few types of SBA loans, such as:
Invoice factoring is most beneficial for businesses with their capital tied up in invoices that customers haven’t paid yet. Instead of waiting for the outstanding payments, you can exchange your outstanding invoices with capital through a lender, but you’ll likely not receive the full value of the invoices in the end.
It’s essentially a trade-off: you sacrifice a percentage of your future capital for cash today. Generally, you’ll receive 85% to 95% of the total value of your invoices, so make sure your business can sustain that loss if you’re seeking invoice factoring.
So, what is a working capital loan?
Working capital loans are best for solving short-term challenges in your business’s day-to-day operations. While you can secure higher amounts of funding through an SBA 7(a) loan, the majority of financing options are designed for immediate problems.
You might want to consider a working capital loan for:
Before you agree to a working capital loan, you should ensure that you’re able to pay back the borrowed amount within the terms. In most cases, working capital loans are tied to your personal credit, which can negatively impact your score if you make late payments or default.
Some lenders might require you to offer an asset as collateral before you’re approved for a working capital loan. A working capital loan with collateral is otherwise known as a secured loan, whereas one without collateral is considered an unsecured loan. Secured loans are the most common, as many lenders want to have the extra layer of security before granting approval.
Although unsecured loans are less common, you can still see if you qualify for one. Typically, these financing options have stricter eligibility requirements compared to secured loans, so you might have to have a higher credit score, longer time in business, and higher profits to be considered eligible.
Offering collateral is always a risky endeavor. You should carefully review your financial information to ensure that you’re able to pay back the loan within the repayment period. Otherwise, you might lose your asset, which can cause a serious headache for you as you try to grow your business.
Working capital loans can help you set your business on a path to success, but only if they’re managed responsibly and appropriately. Here are a few tips to help you manage your loan for the best results:
Securing a working capital loan might sound easy, but it’s actually much more difficult than you’d think. Different lenders will have different requirements and terms, so you’ll likely have to take the time to sift through your options and find the right deal for your circumstances.
Here are a few steps to take to ensure you’re ready for the process:
Apart from “What is a working capital loan”, you can always check our working capital loans guide here if you have any extra questions.
As you can see, finding the right lender to finance your business takes time, which is something not many business owners have. Between the extensive research and the need to compare lenders, many business owners might find themselves struggling to find a lender with terms that meet their needs, but National solves the problem.
Our team leverages a 75+ lender marketplace that can connect you to funding within a few days, saving you the time and resources you would have spent comparing lenders.
Our Business Finance Advisors work with you every step of the way, making sure to learn all we can about your business and goals to make the process as easy as possible. Not only that, but we’ve streamlined the entire process for you. You don’t want to waste time, and we definitely don’t want you to either.
Our team genuinely cares about your business; We’re there for you before, during, and after the deal is funded.
Ready to get started? You can fill out our streamlined application in 60 seconds and take the first steps toward taking your business to the next level.
National Business Capital helps entrepreneurs secure quick and fair financing to save time and cultivate sustainable growth.
Our stress-free online platform is designed for simplicity and speed, helping business owners go from application to approval in a matter of hours. And while we remain a leader in the Fintech industry, our clients agree it’s our personalized service and award-winning team that sets us apart.
From SBA loans to lines of credit, to equipment financing, and more, business owners can access all the different financing programs available to them in one place. Through our streamlined process, we have helped clients secure $2 billion in financing since 2007, and, more importantly, we’ve helped entrepreneurs save a tremendous amount of time and grow faster.
Amanda is the Marketing Coordinator for National Business Capital. She’s a graduate of Ziklin School of Business at CUNY Baruch College and holds a B.A. in Advertising, Marketing, and Communications. Amanda has extensive experience creating content, directing outreach campaigns, and managing operations. She is passionate about small business and helping entrepreneurs reach new heights.