Working capital is precisely what it sounds like. You own a business, and everything seems to be working fine, but you need a little help. Maybe you’re navigating a slow season, or you’re getting ready to expand, and you need a jump start. Either way, working capital could help.
What is a Working Capital Loan?
Working capital loans are used to help you in your everyday business operations. They aren’t typically used to invest or buy assets, but they are used to provide the capital your business needs to keep working. This is where working capital gets its name. They’re not necessarily supposed to carry your business through for an extended length of time. These loans are borrowed to finance your day-to-day operations at times when profits are not enough to cover them.
Things you could use a working capital loan for are necessities like rent, debt payments, or payroll. It can help keep your business afloat, and your staff employed until invoices can be paid or business picks back up.
Some industries that may benefit from the funding of a working capital loan are manufacturing plants which cater to the retail sales cycle, retailers that tend to be busier during the holidays, or businesses that supply services like lawn care and pool maintenance. Working capital loans can help pay overhead while sales are slow and are typically paid off by the time the busy season starts again.
How Do Working Capital Loans Work?
Companies who have cyclical sales or seasonality to their businesses can usually count on a working capital loan to assist when business is slow. This is especially true if they don’t have any liquid assets or enough cash on hand to get through the lull. It can also be helpful when sales are not as predictable compared to other times throughout the year.
The working capital loan payment structure is short. Twelve months or shorter is typical for this kind of loan. Depending on the terms lenders and businesses agree upon, payments are made more frequently than once per month. They can be either weekly or daily.
The interest rates of working capital loans can cause a bit of a shock when you first see the numbers. Generally, you will pay between 1.2 and 1.5 times what you originally borrowed. That’s a 20 to 50 percent interest rate. However, because these loans are short-term, the amount you’re borrowing is relatively small, and you make payments so frequently, it doesn’t feel as high.
In the world of working capital loans, those rates are relatively low. There are working capital loans that charge upwards of 100 percent or more of the original amount. It’s essential that borrowers pay attention to the terms of their loans, and they must be extremely mindful when agreeing to them.
Working Capital Loans vs. Other Financing for Your Business
Working capital loans are for businesses that are already established and are very different from startup capital. Startup capital can help an up-and-coming company get the funding needed for marketing, hiring, initial inventory, and much more.
Working capital also differs from business lines of credit that allow you to borrow against them continually. You can borrow up to a predetermined amount based on specific terms that have been established by your bank. You pay them back as you borrow, and the line of credit stays open for as long as you need it.
You can also get invoice factoring, which is a type of funding that service companies can use to collect money on unpaid invoices. It allows businesses to sell their outstanding invoices to what is essentially a collection agency, and then the agency makes its profit by collecting on those balances.
Financial Benefits of Working Capital Loans
There are many benefits of working capital loans, including simple applications and quick financing. They don’t have as many of the strict requirements that other funding solutions have and can help you cover your expenses right away. Sometimes you can apply online and have your money in as little as 24 hours.
This type of financing also doesn’t require any equity transactions. That means that, as a business owner, you keep full control of your business and don’t have to put up equity in exchange for money. In some cases, you don’t even need collateral, but that depends on your credit rating and other eligibility criteria.
Downsides to Working Capital Loans
While a working capital loan may be the right solution for your business, there can also be drawbacks. The interest rates are relatively high to compensate for the risk that the lender is taking on to loan out the money.
In some cases, they are securitized, meaning that you have to put up collateral to secure the loan. This could include inventory or other assets that belong to your business. If you don’t pay, the lender will take your assets.
These types of loans are attached to the business owner’s personal credit rating, so any missed payments can damage not only your business but your personal finances as well. It’s essential to be aware of these potential risks up front before you take on any debt for your business.
You May Need a Working Capital Loan
There are plenty of situations in which you may need working capital. When the holidays approach, you will be stocking your shelves with the items that make your seasonal retail shop shine. However, making large inventory purchases can be tough on the expense sheet. Working capital loans can help you get ready, and they’ll be much easier to pay back after the holiday rush.
Sometimes you can’t anticipate a sudden increase in demand for your products or services. If you finally land that big client, but you don’t have the resources to supply their needs, working capital can help you increase staff, purchase extra supplies, or grow your business so that you can take on more work.
However, be careful with working capital loans when consolidating bills or purchasing assets. There are other types of business loans structured to handle those particular situations better. It’s imperative to research your options and investigate different solutions that are better suited to your needs.
Working capital loans are great for all types of businesses and many different situations. If you find yourself short on working capital to keep your day-to-day operations running smoothly, a working capital loan may help. Do your research to ensure that it’s the right solution for you. You can help your business with additional working capital while protecting your employees and your assets at the same time.