Tips to Qualify for Small Business Operating Capital Loans?

Working capital or operating capital, is the lifeline of any business. It's the money that covers daily expenses, from payroll and utilities to inventory purchases and marketing campaigns. Without sufficient working capital, a business can struggle, even when it's turning a profit, simply because the timing of revenue and expenses is not aligned with the business's cash flow. For many growing businesses, a working capital loan is a lifeline that helps them manage the ups and downs of business and balance evolving business needs with cost-effective business growth.

To qualify for a small business operating capital loan, small business owners and their businesses typically need to meet a threshold of eligibility requirements. Lenders view this type of business funding with a focus on liquidity and short-term repayment ability, making the qualification process different from long term loans, like commercial real estate or major equipment financing.

In this article:

• Understand common eligibility requirements for small business operating capital loans to cover business expenses.
• Learn how business working capital loans can provide fast funding to address a variety of evolving business needs.
• Discover how different loan programs and loan application processes vary between financial institutions.

Types of Small Business Operating Capital Loans

The best working capital loans for small business vary depending on your business needs, eligibility criteria, and the type of loan you're looking for. While small business operating capital loans are generally designed for short term borrowing that doesn't mean you're restricted to traditional term loans, in which you receive an upfront lump sum that you repay with monthly payments.

There are a variety of potential loan options that could operate as short-term loans or working capital lifelines for your business:

• SBA loans: The U.S. Small Business Administration (SBA) is the gold standard for business lending. The popular SBA 7(a) loan program and its CAPLines program offer highly competitive small business operating capital loans that offer long terms and low fixed rates due to the partial guarantee from the federal government. Qualifying requirements are strict, however, requiring high credit scores and thorough documentation.
• Short-term loans: Both traditional financial institutions, like banks and credit unions, and online lenders offer short-term small business operating capital loans. Traditional lenders have stricter credit approval standards and slower funding times, but can usually offer lower interest rates than online lender financing options.
• Business lines of credit: A line of credit is one of the best options for ongoing, flexible working capital needs. This revolving credit facility allows you to withdraw from a maximum loan amount and repay what you borrow to regain access to the full amount.
• Business credit cards: It's not advisable to use business credit cards for substantial purchases, but they can be useful tools for small, ongoing purchases like office supplies or travel expenses. They tend to be much easier to qualify for than small business operating capital loans.

Qualification requirements will vary by lender and credit type, but let's take a closer look at some of the common lender considerations for the best business capital loans.

Core Eligibility Requirements

Every lender has its own structured evaluation process to determine eligibility for financing, such as small business operating capital loans. While criteria may vary a bit between lender and loan type, there are usually three fundamental considerations across the board.

Credit Score

Creditworthiness is the primary indicator of a borrower's reliability. Lenders will examine both your personal and business credit standing.

Most borrowers will have a personal credit score, which measures how well they have managed credit in the past and how likely they are to repay a loan. A higher credit score translates to a lower interest rate. Lenders review personal finances because they may indicate how an applicant manages business financial obligations.

Established businesses that have borrowed before will have a business credit score. This score reflects the company's track record of paying vendors and other business debts. A strong business credit history will help you qualify for larger small business operating capital loans, or overcome collateral or personal guarantee requirements.

Time in Business

Experience matters to lenders. A longer operating history shows a proven ability to manage economic downturns and generate revenue. Traditional banks usually require a minimum of two years in business to qualify for a competitive small business operating capital loan. Alternative lenders may have more lenient time in business requirements, although that may come at the cost of higher interest rates and shorter repayment periods.

Revenue

Lenders will be repaid from your business's revenue, so they want to see high-volume, predictable sales. Most providers of small business operating capital loans have a minimum annual revenue threshold to ensure the business can comfortably handle new debt. That number may vary between lenders and loan products.

Lenders will analyze your bank statements to find consistent deposits and a pattern of positive account balances, which are key indicators of the cash available to repay a working capital loan. It's a good idea to use your business plan to explain how a business working capital loan could help your company generate more revenue to make repaying the debt easier.

Cash Flow Requirements

Many lenders evaluate small business operating capital loan eligibility through cash flow because funds are meant to be repaid quickly from the business's short-term earnings. As such, lenders will often look at three key areas:

• Working capital ratio: Your current assets minus your current liabilities is your business's working capital ratio. This important number tells a lender how much your business has in liquid assets compared to short-term debt. A ratio below 1:1 shows the business will be unable to meet its payment obligations, making it a high-risk candidate for a small business operating capital loan.
• Debt service coverage ratio (DSCR): The DSCR measures the cash flow available to service debt obligations. This measure of your net operating income and your total debt owed tells the lender how much cash flow you need to generate to cover the loan. A high DSCR can help you secure a more competitive small business operating capital loan.
• Accounts receivable / payable: Lenders will examine your accounts receivable aging report and accounts payable aging report to see how quickly customers pay you, and how quickly you pay suppliers. Many unpaid invoices suggest potential future cash flow strain. Slow vendor payments may signal existing cash flow problems. Both could complicate your application.

Documentation Requirements

To secure a small business operating capital loan, you have to show that your business is already in good financial standing. To do that, you'll need to submit some documentation. Missing or disorganized documents can delay the approval process or lead to outright rejections. Lenders have different requirements, but you'll commonly need:

• Profit and loss statements
• Balance sheets
• Cash flow statements
• Business and personal tax returns from the last two years
• Debt and assets
• Business plan
• Company information, including Articles of Organization, ownership, and operating agreement

Using a professional accounting software like QuickBooks or Xero will make it easier to generate clean, dated reports to enhance your application's credibility.

In some cases, you may need to provide collateral to secure a small business operating capital loan. In such cases, you'll have to show information about the collateral you're proposing to use to prove that it is in good condition and worth the loan amount you're using it for. Also, almost all small business debt requires a personal guarantee from small business owners. As such, you'll likely need to show information about your personal assets, including bank accounts, stock holdings, and other held assets to show that you can repay the loan if the business doesn't.

Final Thoughts

Small business operating capital loans can help your business manage the day-to-day more effectively and plan for long-term goals. By proactively preparing your financials, maximizing your credit scores, and accurately demonstrating your repayment capacity via cash flow metrics, you'll improve your chances of qualifying for the best business capital loans. This guide can help you better prepare for the application process.

FAQs About Small Business Operating Capital Loans

1. What is the most important financial document a lender looks at for a working capital loan?

It depends on the lender, as each may weigh different documents and applicants in unique ways. Generally speaking, a cash flow statement is important because it demonstrates the movement of cash in and out of the business, showing the business's capacity to cover new debt payments.

2. Can I use a small business operating capital loan to purchase fixed assets?

Usually not. Small business operating capital loans are for short-term operational expenses. While you could potentially buy some lower-cost equipment, purchasing long-term fixed assets like real estate or heavy machinery will typically require a dedicated term loan.

3. If I have poor personal credit, can my business still qualify for a loan?

It's harder since most small business loans require a personal guarantee, but you may be able to find lenders that specialize in high-risk financing. Even a small working capital loan may have higher interest rates and stricter terms if you have lower personal credit. You may have to provide valuable collateral to offset the risk.

4. What is the Debt Service Coverage Ratio (DSCR) lenders want to see?

Most lenders look for a DSCR of 1.25:1 or higher to determine whether a borrower is low risk. This means that the business's cash flow exceeds its total current and proposed debt obligations by a 25% margin.

5. How quickly can I receive a small business operating capital loan?

It depends on the lender and type of loan. Online lenders can offer decisions quickly. Traditional banks tend to need a few weeks. SBA loans can take even longer due to their exhaustive due diligence process.

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