A working capital loan can be used to fund the everyday operations for a business. These loans give a company additional funds to cover its short-term operational requirements and can be used for any business use case. Working capital loans are not generally meant for long-term purchases or uses however the lender cannot restrict its use.
A working capital loan is corporate debt used to fund the everyday operations for a business. These loans give a company working capital to cover its short-term operational requirements and can be used for any business use case. Working capital loans are not generally meant for long-term purchases or investments.
There are four working capital loan types. All of these loan types can help businesses fill gaps in their financing, make up for seasonal variability in income and cover payroll expenses. The types are: term loans, lines of credit, SBA loans and invoice factoring.
A business term loan is a lump sum of money you borrow from a lender, and pay back at a fixed interval— with interest — over a set period of time. Many businesses choose term loans because they don’t want to dip into their capital reserves but would rather allow a lender to finance their capital use (projects and business capital needs) at a fair price. In most cases you’ll pay off the loan monthly, however other payment terms might be available on a case-by-case basis. For example, some lenders offer daily, weekly and bi-weekly repayment options in addition to monthly options. Repayment periods generally begin at 12 months and last up to 10 years.
Term loans typically include these features:
Term loans are best to use when your business needs to invest in a longer-term enhancement or business improvement, or simply for a use case that will not diminish in a short period of time. Additionally, when the expected return on investment (ROI) is greater than the cost of the loan, then the term loan can be a great choice. It's less desirable to use a term loan when you are in a temporary cash crunch as this could drag your business down.
A business line of credit is revolving credit, allowing you to carry a balance that accrues interest. Think of it in the same way as a Credit Card. If you don't use the line of credit, you don't have to make any payments. Once you draw from the credit line, as long as you make the minimum payment each month, you can either pay your balance in full or pay whatever you can afford and keep in mind that your unpaid balance will accrue interest.
Typical features of a business line of credit include:
Business lines of credit offer more flexibility compared to term loans since businesses obtain access to cash up to a credit limit, and only pay interest on the amount they have borrowed. Businesses can draw and repay the financing as often as they wish, provided they stay current on payments and stay at or below the credit limit.
An SBA loan is guaranteed by the U.S. Small Business Administration.
These loans are designed to assist small businesses begin, maintain and expand. There are several SBA loan programs created for a variety of purposes and applicants. Each program contains its own loan sizes, terms and rates.
The primary SBA loans for working capital debt are:
Invoice factoring allows small businesses to obtain cash fast without needing to be eligible for a traditional loan or dealing with a long application process.
Invoice factoring is a procedure where a business sells its invoices to a third-party factoring company at a cost for a portion of the unpaid balances, typically 85%-95% of the full value.
For example, if your business provides an invoice to a customer for $5,000 and if the customer has up to 60-days to pay the invoice, your business is stuck waiting to be paid. A factoring company will purchase that invoice from you for a certain amount, for example $4,850. The factoring company will pay you upfront so you don’t need to wait on the payment from your customer.
If a business has clients that haven’t paid their invoices yet, this type of working capital loan lets them convert the invoices quickly into working capital subtracted by any fees.
The factoring company purchases a portion of the company’s invoices for an upfront payment and then gets reimbursed when the company’s client pays it directly.
Working capital loans work to fund everyday financial operations for businesses that do not have consistent cash flow or revenue stream. This loan product is typically utilized to keep the business afloat, while conserving its cash reserves.
All businesses need to have cash reserves to handle planned and unexpected costs in order to stay afloat. Working capital loans provide a lifeline to businesses by giving them access to cash when they need it.
The calculation for working capital is as follows:
Assets can include inventory, accounts receivable and cash reserves. Liabilities can include accounts payable and other debt.
As an example, assume a business owns $100,000 in assets and $75,000 in liabilities.
$100,000 in Current Assets - $75,000 in Current Liabilities = $25,000 in current Working Capital.
In this case, if an unforeseen cost of $25,000 or more occurred, then the company would run out of money and likely go out of business.
Although credit cards can provide a fast way to pay for unexpected expenses, they tend to have expensive interest rates and low limits. Another option is a working capital loan, which can provide immediate cash for businesses to overcome emergencies or downturns in business.
A business can use a working capital loan to pay for things like debt, payroll and rent. If a company has a bad season, a working capital loan can keep it alive during the following months after revenue drops.
Working capital loans may not require a company to offer up collateral and in many cases can be approved within a few hours and funded the same or next day. They are a flexible option for businesses to consider when they need cash quickly.
A working capital loan can be used to pay for short-term business costs tied to day-to-day operations.
Examples:
There are a handful of pros and cons for working capital loans:
Working capital loans cost a business in two ways.
First, to obtain a working capital loan the business may be required to pay an origination fee to the lender in addition to interest or other fees.
Second, a working capital loan will typically have an interest rate ranging from 6% - 39% or factor rates between 1.19 - 1.35. The rate can vary depending on the type of working capital loan, the borrower’s credit rating and other factors.
A working capital loan can be a terrific option for businesses that are small, new, don't have typical collateral or just happen to be in a cash flow slump.
This type of debt may be a good option for businesses that have limited cash reserves and require cash to cover their daily costs. Working capital financing can give businesses a chance to survive, especially seasonal businesses that usually go through a decline in revenue during the off-peak months.
A working capital loan is generally a short-term solution to a short-term problem, and it isn't the best way for a business to fund long-term investments or projects. For businesses that need to borrow for that type of reason, it’s better to evaluate a business term loan as a potential solution.
When a company decides it would like to apply for a working capital loan, then it should follow the steps outlined below.
With Lendzero, applying for a working capital loan is easy.
Step 1: Click on the Get Approved button above and answer a few basic questions about your business. We will inform you about your best options and how many exist (this will set your expectations).
Step 2: After this is complete, you will be asked to create a username and password to begin your electronic loan application. This process normally takes about 6 – 7 minutes (if you have all your documents easily accessible and ready).
To complete the loan application, here is what you will need to have handy:
Step 3: Once the application process is complete, we will send you the completed loan application for you to review and sign. Once you have signed for your application, the process is complete. You have officially applied and started your journey to receiving pre-negotiated working capital loan funding offers. Your Lendzero funding specialist will reach out to you to guide you through the remaining steps of the process, and provide the necessary guidance and support needed with the goal of successfully obtaining the proper loan.
