What is a Working Capital Loan?
The term ‘working capital loan’ refers to any type of financing that helps a company cover everyday expenses. These loans can be used for short-term operational costs like rent, payroll, and accounts payable. They aren’t used for long-term investments or purchases
One of the reasons why working capital is so important is that it can be used in so many different ways that are critical to the survival of the business. It represents an essential source of capital particularly during times when business revenue isn't fully covering business expenses. For example, working capital can be used for any of the following expenses:
- Purchasing inventory
- Hiring new employees
- Paying taxes
How to Choose a Working Capital Loan
When searching for a working capital loan, always compare lenders by rates, repayment terms, loan amounts, and reputation. But most importantly, check that lenders offer the right type of working capital for you.
Generally speaking, any type of financing designed to cover a business’ daily expenses could be termed a working capital loan.
The Main Types of Working Capital Loans
Business line of credit
Business line of credit is a flexible type of funding where the lender agrees to supply credit to a business. The business may withdraw funds at any time, up to the credit limit set by the lender. The business repays only what they withdraw, plus interest. As the business repays the principal, the amount is added back to their credit balance.
An advance on a business’ accounts receivable that allows the business to obtain funds without taking on debt. Let’s say the business has invoices for $20,000 due in 90 days. Rather than wait for 90 days, the business sells its invoices to the lender for a fee.
Merchant cash advance
An advance on a business’ future sales that allows the business to obtain funds without taking on debt. The two parties agree on a percentage of daily, weekly, or monthly sales to be automatically deducted from the business’ bank account.
Unsecured short-term business loan
Some lenders offer a version of a short-term business loan that is actually called a working capital loan. These loans have repayment terms of 6-18 months. Some lenders calculate repayments by factor rate rather than interest rate—making this similar to invoice factoring or a merchant cash advance. Repayments are automatically deducted from the business’ bank account every day or week. Unlike a regular business loan, no collateral is required (and, therefore, the application process is simpler).
What are the Requirements for Working Capital Loans?
Some types of working capital financing are easier to get approved for than others. All types require the business to have been in operation for a minimum period of time and to generate a certain amount of monthly revenues.
When you apply for working capital, you can expect to be asked for the following:
Information about yourself (and any partners with a 20% share or more in the business)
Information about your business, such as what it does and how long it’s been in operation
Social Security number, so that the lender can run a credit check
Estimated monthly business revenue (or, in some cases, proof of revenue)
Recent bank statements
Details about your invoices
Why Use a Working Capital Loan?
According to a US bank study, poor cashflow management is a factor in 82% of small business failures. Invest too much cash in growing the company and you leave too little for everyday expenses. Keep too much cash in the bank and you prevent yourself from growing. Working capital loans solve this problem by providing financing for operational expenses, letting you dig into your cash reserves to invest in and expand your business.
Working capital will allow your business to continue to grow no matter what happens. One way to ensure a healthy and strong working capital is by reading reviews and collaborating with a suitable lender that has the strength and financial immunity to offer ongoing cash flow to fit your needs.