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How can you get working capital for new business, and use it drive business growth in 2022? Find out more in this article!
Working capital is a term used to describe the money a business spends on its daily operations. Payroll, rent, utilities, and debt obligations all fall into this category of business expenditures, but it also encompasses other short-term expenses, such as the launch of a new marketing campaign.
All of these items require a business owner to have cash on hand, which is sometimes difficult if they’re in an industry that regularly deals with cyclical or seasonal sales.
If your business activity isn’t constant throughout the year, you might find yourself strapped for working capital during your low revenue months. Rather than dip into your personal savings account to cover the cost, you could consider a working capital loan, a short-term financing option designed for this very situation.
There are many working capital loan uses, but generally, a business owner will use one to offset the financial burden of low revenue months. Here's everything you need to know about working capital for new business and how to take full advantage of all the opportunities.
Working capital for new business. Source: cfi.com[/caption]
One option is a working capital loan, a lump sum payment that they can use to pay their bills and hold themselves over until they’re profitable.
Many industries outside of construction deal with the same set of issues. However, working capital loan uses aren’t limited to these few, as you can use this financing option to fund your business growth and take your business to the next level if you manage them correctly.
Working capital loans are often used to fund short-term expenditures, such as the launch of a new marking initiative, and help businesses hire more employees to prepare for a surge in activity.
1. What is working capital?
So, what is working capital? A working capital loan is a short-term financing option that is used to cover the operational expenses of a business, including payroll, rent, utilities, and debt obligations. While a working capital loan can’t be used for larger expenditures, such as an aggressive expansion, it can help you pay liabilities during periods of low revenue or business activity. For example, construction companies will typically take on more contracts in the summer months. Most of their profit comes from these months of high business activity, and they might not generate enough revenue during the winter to cover their expenses. Vehicle repairs, payroll, and any payments on equipment leases don’t stop just because of the weather, so these businesses must find a way to pay these bills to ensure they’re in a good financial position to start generating revenue again in the following year. [caption id="attachment_3447" align="alignnone" width="768"]2. Types of working capital loans
There are numerous types of working capital loans that you can use to finance your business, such as:2.1. Term loans
When it comes to working capital for new business, one option are term loans. A term loan is what most people think of when they hear business financing. Working capital term loans are lump-sum payments for a specific amount that you have to pay back within the repayment period. You’ll likely have to pay an interest rate on the amount borrowed, too, but the specific percentage of your interest rate will depend on the lender you’re dealing with, the repayment terms, and your credit score, amongst other things. Additionally, you might be required to offer collateral to secure a term loan, but once again, this depends on the lender you’re doing business with.2.2. Lines of credit
Much like a credit card, a working capital line of credit is a revolving line of credit that a business can draw on whenever they need additional capital, making it a good option when it comes to working capital for new business. One of the benefits of this option is that you only pay interest on the amount drawn rather than the total credit amount, making repayments easier and less stressful if you aren’t using the full line. Repayment terms for working capital lines of credit are generally between one to five years, and you can potentially tailor your terms to your circumstances if you speak with your lender. Although working capital lines of credit might sound similar to a business credit card, the two are very different. Business credit cards can only be used for transactional purposes, meaning that you can’t draw physical cash without a hefty fee. Some businesses might benefit more from a business credit card than a working line of credit, but this is usually if the organization mainly relies on transactions and doesn’t need to make cash payments. You can learn more about the differences between working capital loans vs line of credit in this article.2.3. SBA Loans
A Small Business Association (SBA) loan is a more formal financing option that’s highly coveted due to its low-interest rates. These loans are backed by the government, meaning they agree to cover an agreed-upon portion of your outstanding debt if you default. Lenders see that your loan is backed by the government and will offer lower interest rates and more flexible terms as a result. Fortunately, the SBA is flexible on qualifying expenses, too, so you can potentially use an SBA loan to cover expenses outside of your working capital. SBA loans are further broken down into the following categories:- SBA 7(a) Loans: 7(a) loans are amongst the most popular SBA loans, as they offer the highest borrowing amount of $5 million. Since you can borrow so much, many business owners use 7(a) loans for expenses outside of working capital, such as real estate purchases and expansion projects.
- CAPLines: CAPLines are a flexible option for business owners who don’t want to be confined by the terms of a loan. You can choose between a traditional term loan, a line of credit, a builder's line of credit, or a working capital line of credit, depending on the needs of your business. Typically, CAPLine funding goes up to $5 million and has a ten-year maximum repayment period.
- SBA Microloans: Unlike the previous options, SBA microloans are designed for startup businesses or new businesses looking to kickstart their growth. Borrowing amounts are up to $50,000; the maximum repayment period is six years, with the average repayment lasting around 40 months. Although these loans are technically designed for new businesses, any organization can apply to use one for working capital purposes.
2.4. Invoice factoring
Some businesses run into issues when their customer invoices aren’t paid on time. This can leave them waiting for long periods of time without their revenue, but invoice factoring can help restructure your cash flow. Invoice factoring involves exchanging your outstanding invoices for immediate cash, but you likely won’t be able to recoup the total amount of the invoices. Generally, you’ll be able to receive anywhere between 85% to 95% of the total value of your invoices. It’s a trade-off: cash today for a small portion of your total outstanding accounts receivable. If you’re considering this option, make sure your business can support losing a portion of its outstanding invoices, or you might run into additional cash flow problems.3. Working capital for new business: uses
Working capital for new business can be used to cover your business's operational or day-to-day expenses. There are many ways to use this financing option to support your growth, such as:- Paying Rent: Businesses that make a majority of their profits during a specific period of the year might have difficulty paying their expenses during the low revenue months. Rent payments won’t stop just because it’s cold outside, but a working capital loan can help you stay afloat as you wait for the next revenue boom.
- Payroll: Seasonal companies might keep some employees on their payroll despite the periods of low revenue. While these employees might be vital to the success of the company, you can’t pay them without profit, which puts you at risk of losing them for the following season. Working capital loans can help you cover payroll costs, keeping your team together for as long as possible.
- Bridging the Gap Between Payment Delays: Late customer invoices can cause cash flow problems and make it difficult to pay off expenses. Rather than wait for these customers to pay you, a working capital loan can allow you to continue your business operations despite the late payments.
- Hiring New Employees and Staff: If you need an influx of cash to hire and pay new employees, a working capital loan could be exactly what you need.
- Equipment Updates/Repairs: Some industries, like construction, rely on heavy equipment and machinery to conduct their business operations. In some cases, this equipment might need repairs, updates, or maintenance during low revenue months to ensure they’re ready for the following year. Many business owners choose to cut costs in other areas of their business to afford these expenditures, but why not keep your business exactly as is and secure a working capital loan to afford the expense?
- Afford New Technology: New technology can improve your client’s experience and make it easier for your employees to perform their job. If you discover a tech item that could be a gamechanger for your business, and can’t afford it at that moment, consider applying for a working capital loan to take your business to the next level.
4. Secured vs unsecured working capital loans
When talking about working capital for new business, it's important to differentiate between secured and unsecured options.4.1. Secured working capital loans
A secured working capital loan requires you to offer an asset as collateral before the lender approves you for funding. Real estate, equipment, and vehicles can all be used as collateral for a loan, but make sure you’re able to pay back the borrowed amount within the terms, or you’ll risk losing the asset. Most businesses try to avoid lenders who require collateral, but it might be your only option if you have a low credit score and a short time in business. However, that doesn’t mean you shouldn’t still search for funding that meets your needs, and you might be able to find a deal that works for you through a marketplace.4.2. Unsecured working capital loans
Some lenders will approve you for a working capital loan without requiring collateral, but you’ll likely have to pay a higher interest rate. Unsecured loans are generally considered riskier because of the lack of collateral, which forces lenders to enforce strict eligibility requirements. In most cases, unsecured loans are granted to businesses that can display positive cash flow and sustainable revenue, as the lender needs to understand that you’re capable of paying back the borrowed amount within the terms.5. Working capital for new business: pros and cons
Working capital loans aren’t for every situation. Here are the pros and cons of working capital loans:Pros
- Short-term funding solution for your operational expenses
- Might not have to offer collateral
- Faster funding
- Ability to improve your personal credit if you repay early
- Keep ownership of your business
Cons
- Not necessarily a long-term solution
- Might need to offer collateral
- Higher interest rates, if approved for an unsecured loan
- Tied to your personal credit score
- Need to repay the borrowed amount in a short period of time