What is a Working Capital Loan?
Working capital is an accounting term used to describe a company's liquidity. When a business is liquid, it means it has enough money to meet its current, short-term obligations. Working capital is what you use to pay for day-to-day operating expenses like salaries, rent, and utilities.
A company needs working capital to fund and plan for sustainable growth. When a business doesn't have enough cash on hand to meet its working capital needs, it looks for loan options offered by banks and other providers like online lenders.
For example, working capital loans can provide small business owners with funding to keep their businesses afloat during low sales seasons. They can then use the funds to pay for any business expenses, including office space rent, inventory, salaries, and equipment repairs and maintenance.
Types of Working Capital Loans
Below are the different kinds of loans you can apply for that are considered working capital loans:
Short-term loans: A short-term loan is the most common form of working capital financing. A short-term business loan is an unsecured loan that gets you approved for a fixed loan amount. You'll pay it back in regular monthly payments plus interest for a specified term length (i.e., the loan term).
Business line of credit: With a business line of credit, you get access to capital with a set credit limit that you can use on an as-needed basis. It works the same as a credit card or a home equity loan. You only get charged interest and have to make payments for the amount you use.
Invoice factoring: Invoice factoring, also called invoice financing, allows you to borrow money by using your accounts receivable as collateral. You can look at it as an advance on your unpaid invoices, possibly receiving up to 99% of your invoice amounts upfront. You pay the lender a factoring fee and they get their money back when they collect from your customers.
Merchant cash advance (MCA): A merchant cash advance, also called a credit card processing loan, allows you to receive cash immediately in exchange for a percentage of your future sales. Like invoice factoring, it's an advance based on your company's creditworthiness, future sales, and past credit card receipts. Repayment is based on a percentage of the daily balance in the merchant account.
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What Can Working Capital Loans Be Used for?
Working capital loans can be used for practically anything. However, many businesses use working capital loans when they need additional funds to pay for everyday business expenses while waiting for customer payments. Below are some common situations when you might want to take on a working capital loan.
Cash Flow Gaps
Sometimes, gaps in cash flow happen due to customers not paying on time or emergency situations, like broken equipment that needs to be repaired. A working capital loan can be used to bridge a short-term solution to the gap, ensuring your bills get paid on time.
Seasonal Lows
Many businesses make most of their sales during high sales seasons, such as the summer, winter, or holiday seasons. During seasonal slumps, however, companies may struggle because cash reserves can be used up quickly.
This is where working capital loans come in. This type of loan can provide the capital needed for companies to keep their businesses in operation even when there's less money coming in.
COVID-19 Assistance
The COVID-19 pandemic has negatively impacted many businesses, with some companies even having to close up shop due to low sales and increased expenses. If you require additional working capital to keep your business open, Clarify Capital is here to help.
Operational Costs
Working capital loans provide a safety net for startups and new businesses to stay afloat while they grow and get more customers. This type of loan can be used to pay for expenses that accrue every day (e.g., rent, utilities, and payroll).
Additional working capital can also help your business grow. With more money, for instance, a business owner can take advantage of supplier discounts by purchasing in bulk.
Emergencies
Just like in your personal life, unplanned costs and emergencies happen to businesses, too. But what if a company has its money tied up in inventories or other investments? That's where working capital loans are used — these funds can cover urgent expenses and provide financial relief during emergencies.
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When Does It Make Sense to Use a Working Capital Loan?
A working capital loan is beneficial for businesses that need access to quick capital to cover operational expenses. This is because this type of financing is easy to apply and qualify for. Most forms of working capital loans are also unsecured, which means no collateral is needed to secure the loan.
While business owners can also get funds through equity financing, this requires them to give up a percentage of their ownership of the company. Working capital loans offer an alternative option for business owners who need additional funding but who also want to retain full control of their businesses.
If you're considering any type of business financing, make sure you understand your business needs. For instance, what do you plan to do with the money and how long will you need it? Before you take on any loans for your business, make sure you have a plan on how to pay that money back.
How Hard Is It to Get a Working Capital Loan?
Working capital loans are easily accessible and available for many different sizes and types of business. Most forms of working capital loans, such as short-term loans and business lines of credit, are unsecured, which is helpful for small companies that may not have current assets to secure a loan.
In addition, the application process is generally quick, and funding can be issued within a couple of days. Thus, working capital loans are an obvious choice for companies looking for quick capital infusion with flexible repayment terms.
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