How Working Capital Loans Can Support Your Business Operations
September 17, 2024 | Last Updated on: September 17, 2024
Disclaimer: Information in the revenue-based financing articles is provided for general information only, does not constitute financial advice, and does not necessarily describe Biz2Credit commercial financing products. In fact, information in the revenue-based financing articles often covers financial products that Biz2Credit does not currently offer.
Being a small business owner means juggling multiple priorities at the same time. And the buck stops with you—there's no one to tell you which one you should focus on first. When you have strong business cash flow management and a good profit margin, it’s fairly easy to cover operational costs, no matter what type of business you’re in. But when circumstances change—due to a slow period, increased competition, an unexpected expense, or even a new growth opportunity—where do you find the cash to keep your company running? The answer may be working capital loans.
3 Key Takeaways:
- Working capital loans offer immediate access to cash.
- Working capital loans can help you cover several types of expenses, including inventory and payroll.
- Working capital loans can help you take advantage of growth opportunities.
In this article:
- Understanding Working Capital Loans
- Pros and Cons of Working Capital Loans
- How to Determine your Need
- How to Apply for a Working Capital Loan
- Best Practices for Utilizing Working Capital Loans
- Repayment Strategies
- Alternatives to Working Capital Loans
Understanding Working Capital Loans
Working capital loans give businesses and startups the liquidity they need to maintain operations and take advantage of growth opportunities—even when cash flow is down. They can help you cover expenses like payroll, rent, and inventory over the short term. This means that you can stay competitive even if your competitors are struggling. Because working capital financing gives you immediate access to funds, they can help bridge any gap you have between income and expenses. That way, you can focus on growth rather than stressing about cash flow coverage.
Pros and Cons of Working Capital Loans
Benefits of Working Capital Loans
Working capital loans give borrowers fast access to cash. Plus they’re flexible; you can use them for a wide range of business needs. That makes them uniquely useful for business owners that have seasonal demand changes.
Here’s a closer look at these advantages:
- Immediate Access to Cash: Fast access to cash can be essential when you are struggling with cash flow. If you’re not sure how you’re going to pay suppliers or cover payroll, your business could be in serious trouble. A working capital loan can give you the liquidity you need to succeed.
- Flexibility to Cover Operational Expenses: Unlike commercial real estate loans or equipment financing, working capital loans can be used for multiple purposes, including purchasing inventory, paying for marketing, or funding emergency repairs. This flexibility can be crucial when cash is tight.
- Ability to Manage Seasonal Demand Changes: If your business experiences a lot of highs and lows because of seasonality, working capital loans can help. You can use them to stock up on inventory before peak season and avoid cash flow problems during off-peak periods.
Disadvantages of Working Capital Loans
Working capital loans aren’t for everyone. They often have higher interest rates than term loans, and the repayment period is shorter. This can put undue pressure on some businesses. The loan amounts may also not be big enough if you need a lot of cash.
Determining Your Working Capital Needs
Before you apply for a working capital loan, follow these steps to see if it is the best solution for your business needs.
- Evaluate your cash flow. It’s not all about annual revenue. Check your cash flow statements to see if there are any times when you didn’t have enough cash to meet business expenses. If this happens a lot, you may need additional working capital. Be sure to review accounts receivable so you can grasp how quickly you could collect payments from customers and how soon you need to pay suppliers. This can also help you figure out the loan amount that you’d need to receive upfront.
- Focus on business goals. Don't just stick with the status quo. If you have growth goals like launching new products or moving into a new market, what additional funds will you need? Do you have upcoming projects or seasonal demand surges that will require more cash? For example, a landscaping company might need to hire more staff at the beginning of summer, or a retail company might need to stock up on inventory before the holidays.
- Weigh your current financial obligations. If you already have a lot of debt (either traditional loans or on business credit cards), you need to evaluate whether a working capital loan could help you recover. Or maybe, it would just add to your burden without providing real benefit. It's essential that you have a plan in place to use any money that you borrow.
How to Apply for Working Capital Loans
If a working capital loan is the best solution for your business needs, follow these steps to apply.
Gather Necessary Documents
When applying for a working capital loan, you’ll need to provide multiple documents to show that your business is healthy and that you can repay the loan. Here's a list of common documents you will need:
- Articles of Incorporation/Formation
- Balance Sheet
- Bank Statements
- Business Credit Report
- Business License and Permits
- Business Plan
- Cash Flow Statement
- Credit History
- Income Statement
- Loan Application
- Personal Financial Statements
- Tax Return
Check with your chosen lender to confirm their requirements before starting the application process. This will save you time and effort (for example, they can tell you if they offer the loan program you’re interested in). Plus it’s also a good way to start building a relationship with the financial institution. Having a relationship with your bank can be beneficial as they can give you advice and help you get a working capital loan without delay.
Evaluate Several Lenders
You may want to use a traditional bank or credit union, or you may decide to go with an online lender. Traditional banks can offer lower working capital loan interest rates but tend to have stricter requirements and they take longer to approve financing. Alternative lenders typically approve loans faster and have flexible terms, which can be helpful if you need money fast.
Review Terms and Conditions
Before accepting any loan offer, make sure you understand the terms and conditions. The last thing you want is to be surprised when it is time to pay back what you borrowed. Working capital loans can be secured or unsecured business loans. Check the interest rates, repayment schedule, and any fees that are mentioned to make sure they are exactly what you think they are. Reviewing the paperwork before you sign ensures there aren't any errors or unexpected costs that will surprise you down the road.
Best Practices for Utilizing Working Capital Loans
To maximize the benefits of your working capital loan, put the funds to work on the areas of your business that will give you the biggest return on investment, whether that's purchasing high-need inventory, upgrading equipment, or paying employees.
Additionally, be mindful of overborrowing and ensure that you have a clear repayment plan. Mismanaging loan funds can negatively impact your business’s credit score (bad credit makes it harder to get financing). By strategically using the funds and avoiding common pitfalls, you can make the most of your working capital loan and support your business’s growth and stability.
Related: How to Get Working Capital as a Small Business
Repayment Strategies
You can choose from several repayment strategies for a working capital loan. The one you choose will depend on your company's cash flow and on finding a lender that will accommodate you. If you're not sure, check with a financial advisor that specializes in small business financing.
Here are some common repayment options:
- Flexible Daily or Weekly Payments: You may be able to find a lender that offers repayment plans that align with your company's daily or weekly cash flow. This type of repayment structure is helpful if your cash flow fluctuates, as it is tied to your actual revenue, so your payments are manageable during the slow season.
- Variable Monthly Installments: Some lenders will allow repayment terms that fluctuate with your monthly This repayment approach is helpful because it doesn't change as much as daily or weekly payments.
- Balloon Payments: If you have predictable seasonality to your business, or you get large influxes of cash after completing large projects, you may be able to get balloon repayment options. With balloon payments, your regular payments will be smaller, but you'll be expected to make a larger final payment.
- Custom Repayment Plans: If none of the above payment plans seem to fit your business, contact your lender to see about a custom repayment plan. For example, they may be able to set something up that fits seasonal or industry-specific cycles to ensure that your payments support your business growth.
Alternatives to Working Capital Loans
At this point, you may be thinking that a working capital loan might not be the right fit for your needs. Here are several other business finance options to consider:
- Business Lines of Credit: A business line of credit is a type of revolving credit for a businesses not unlike like a credit card, without the card. If your eligibility is approved, you'll qualify for a maximum amount of credit that you can draw from as needed, but you'll only pay interest on the credit that you actually use. This way, you have instant access to cash when you need it, but you aren't making payments if you don't use the credit. These credit lines for small businesses are ideal for emergencies, fluctuating cash flow, or short-term growth opportunities (if you keep taking advantage of overdraft facilities, a line of credit is probably for you, if you are eligible).
- Invoice Financing: Invoice financing provides advances on outstanding invoices. In other words, you improve your cash flow without taking on any debt. Invoice financing means selling your unpaid invoices at a discount to a financing company, who then advances you 80-90% of the invoice value. When your customer pays the invoice, the remaining balance will be returned to you minus a fee.
- Revenue-Based Financing: Revenue-based financing gives your business capital in exchange for a percentage of future revenue. Because it's tied to revenue, repayment fluctuates, making it a flexible option that won't cause stress during slow periods. This is a strong option for companies that want to avoid fixed monthly payments.
- Inventory Financing: Inventory financing is a type of short-term business loan that uses inventory as collateral for the loan.
Related: What to Know About Revenue-Based Financing
Conclusion
Working capital loans are an important tool for small businesses. They help entrepreneurs with managing business liquidity that is needed to manage daily operations, seize growth opportunities, and navigate through financial challenges. By understanding how to effectively use these small business loans, business owners can find peace of mind and grow their businesses without worrying about where the next dollar will come from.
FAQs
What is a working capital loan?
A working capital loan is an operational finance solution designed to cover a business's everyday operational expenses. These loans are intended to help businesses manage their short-term financial needs, including payroll, rent, and inventory purchases, ensuring smooth and continuous operations.
How can a working capital loan benefit my business?=
Working capital loans give you immediate cash flow, cover operational expenses, and help manage seasonal demand changes. By solving cash flow issues, a working capital loan enables you to focus on growth and keep your business running well no matter what the market is doing.
What do I need to qualify for a working capital loan?
To qualify for a working capital loan, you'll need financial statements, tax returns, bank statements, and a detailed business plan. These will help lenders understand your business's financial health, creditworthiness, and ability to repay the loan, ensuring you meet their lending criteria.
- Are there different types of working capital loans?
- Yes, including short-term business loans, revolving credit lines, and overdraft facilities. Each type offers different features and benefits, allowing businesses to choose the best loan option for their business.
- How should I best manage and repay a working capital loan?
- Develop a repayment plan aligned with your cash flow, avoid overborrowing, and consider refinancing options if needed. To get the most out of your loan, you need to keep track of your cash flow, make timely payments, and ensure the loan is used strategically to maximize its benefits and minimize financial strain.
- What are the eligibility criteria for a working capital loan?
Lenders will typically check your creditworthiness, your time doing business, and your annual revenue, as they want to ensure they are offering a loan to a real business, and not just an individual.
Recent Articles
Related Articles
A Business Owner’s Guide to Understanding Working Capital Loan Interest Rates
September 11, 2024