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.

1. What is a working capital loan?

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.

2. What are the different types of working capital loans?

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:

2.1. Term loans

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.

2.2. Business line of credit

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.

2.3. SBA Loans

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:

• SBA 7(a) Loans: These SBA loans are the most common of the bunch. You can borrow up to $5 million with an SBA 7(a) loan, which is why many businesses rely on them for real estate purchases or large expenditures. However, you can use this type of financing for other business activities, including debt refinancing, short-term working capital, and asset purchases.
• CAPLines: CAPLines are flexible financing options for businesses that deal with cyclical or seasonal business cycles. Much like an SBA 7(a) loan, you can borrow up to $5 million, but you can choose between a term loan, line of credit, builder’s line of credit, or a working capital line of credit for the structure. This option is beneficial for any business owner who needs a specific financing structure to support their business growth, but you’ll have to make sure that you pay back the borrowed amount within the 10-year repayment term.
• SBA Microloans: As the name suggests, microloans are SBA financing options for smaller amounts. Typically, you can borrow up to $50,000 with a microloan, making them beneficial options for start-up businesses.

2.4. Invoice factoring

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.

3. What can I use a working capital loan for?

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:

• Cyclical or seasonal business activity
• Cash flow issues
• Payroll expenses
• Hiring new employees
• Purchasing inventory
• Launching a marketing initiative
• Refinancing debt
• Repairing equipment

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.

4. Will I need to offer collateral for a working capital loan?

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.

5. Managing your working capital loan

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:

• Keep an Eye on Your Cash Flow: Working capital loans can help you manage your cash flow during months of low business activity. However, they’re also an opportunity to reevaluate your cash flow. You’ll have the breathing room to evaluate which expenses are the heaviest during your low revenue months, allowing you to reorient and prepare for the next one. If you manage it correctly, you might not need another loan in the future.
• Make Your Payments on Time: Late payments or defaulting on your loan can result in harsh financial consequences for you and your business. Don’t forget: working capital loans are often tied to your personal credit, so you should make sure to pay the correct amount on time every pay period to avoid damaging your credit score. Be sure to keep a detailed record of how much you’ve already paid, the remaining balance, and the repayment terms to maximize the benefits of your loan.
• Monitor Your Expenses: In some cases, business owners think that they can take on new expenses once they’re approved for a loan. While it is exciting to have extra capital, you should only use the funding for what it was designed for: short-term issues. By sticking to this standard, you can avoid overextending the capability of your business and ensure you’re prepared to repay the loan within the term.
• Invest in Your Business: Securing a working capital loan is an opportunity to take your business to the next level. Your loan can give you time to change your business plan to combat the problems you deal with on a daily basis, including delayed customer invoices, cash flow issues, and periods of low business activity. Instead of waiting for the next set of challenges to come along, you now have the time and resources to fix them on your time.

6. How to get a capital loan

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:

1. Understand Your Borrowing Needs: You should first determine how much capital you’ll need to borrow. Make sure it’s a realistic number, as borrowing too much or too little can come with a new set of associated problems. Additionally, you should consider how you want your financing to happen. Do you need a lump sum payment? Or would you benefit more from a revolving line of credit? Both of these are important to your decision, as well as the repayment terms, the corresponding fees, and the interest rate your lender offers. 
2. Review Your Credit Score: Your credit score will play a critical role in the terms you’re offered, including the interest rate, repayment terms, and maximum borrow limit. If you have a poor credit score, it might be beneficial to spend a few months building credit before applying for a loan. Higher credit scores often come with lower interest rates, more favorable repayment terms, and more options for financing. 
3. Research and Compare Lenders: One lender’s terms won’t be the same as the next, so it’s recommended that you speak with as many as you can to find the best deal. Some might offer higher maximum borrow limits, but the interest rates could be higher, and vice versa. You shouldn’t settle for the first offer you receive; Keep researching until you find a financing option that fits your needs and circumstance.
4. Gather and Prepare All Relevant Documents: Each lender will ask for your financial information before offering you their financing terms. Chances are, you won’t have those readily available when you start your search, so it’s best to have them prepared as you go through your research. You should have your business bank statements, tax returns, and business plan readily available as you compare lenders.
5. Submit Your Formal Loan Application: Once you’ve found a lender with terms that meet your needs, you can submit your application and apply for financing. This isn’t a guarantee that you’ll be approved for the funding, but it’s the first step of approval. Some lenders have complicated applications that might take time to complete accurately, so be sure to factor the time to complete the application into your schedule. If you’re denied funding, you shouldn’t give up hope, as there are endless lenders that can help you finance your business. 

Apart from “What is a working capital loan”, you can always check our working capital loans guide here if you have any extra questions.

7. National Business Capital can help make the process easier

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. 

Click here to apply today.