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What You Need to Know About Working Capital Loans

Submitted by Tommy Wyher on Mon, 03/13/2017 - 4:41pm

Trying to run a business without working capital is almost impossible.   However, there are times when your cash flow is not generating enough working capital to make ends meet.  Maybe your business is growing so fast that you can’t keep up with orders, or maybe you have hit a bump in the road and you can get small fast. 

Either way, the need for having access to enough working capital is vital and it is times like these that you might need to consider a working capital loan.  But what are they and how can they help your business?  With that in mind, there is a short list of what you need to know about working capital loans.

What is working capital?

Working capital is the money needed to meet the needs of your business both today and in the short-term - i.e. this week or this month.  Working capital is often the money in your company’s bank account, but it could also include equivalents which can be easily converted into cash.

If you are like many other small business owners, then you probably rely on your personal finances to meet the working capital requirements of your business.  Doing so not only risks assets, such as your home, but will also make it hard to grow your business fast.    As such a working capital loan is often a good choice. 

What is a working capital loan?

Simply put, a working capital loan is money you can borrow to meet the day-to-day needs of running your business; this could include making payroll or buying additional inventory.  While these loans are not structured line traditional bank loans, they are also not for long-term financing needs. 

In addition, working capital loans are usually meant to be paid off within a period of weeks or months and not years.  As such, one thing to remember with working capital loans is that you should get short-term loans for short-term needs.

How Can Capital Working Loans Help

As mentioned, these loans are designed to cover the day-to-day financing needs of running your business.  When times are tough, a working capital loan can give you a little extra cover to make ends meet.  When you are in growth mode, a working capital loan can be used to buy extra inventory or to hire extra staff before your sales receipts catch up with expenses. 

Other advantages of working capital loans is that they tend to have shorter approval cycles – within hours or days – and they are often unsecured loans.  This means that many working capital lenders do not require collateral for the repayment obligations.  

While unsecured loans tend to have higher interest rates, they can be useful for business owners who either want to protect their assets, have pledged their assets to other lenders, or have impaired credit.  In all three cases, the more flexible terms of a working capital loan can help these business owners to get the money they need today for funding needs they also have today.  It is this speed and flexibility which is a big plus.

What are the disadvantages working capital loans?

These are loans and you will need to repay them eventually.  In some cases, a working capital loan is directly repaid to the lender as a percentage of daily sales, while in other cases, the loan will be repaid monthly.  As such, you need to make sure your cash flow can handle the debt service costs.  If not, then working capital loans are not the right choice for you.

In addition, there might be instances when you will be required to offer collateral for a working capital loan.  The plus is that the collateral will help you get the loan, the downside is that you won’t be able to pledge the asset for another loan until the first loan is paid off.   This points out the need to make sure you have a clear repayment plan for a working capital loan, if not then you might want to take a step back before you commit to anything.

Working capital loans can also impact your credit, especially if you need to sign a personal guarantee for the loan, or if you continue to take out numerous small loans for your business.  In this case, you want to consider taking out working capital loans under your business’ account and not under your personal credit.

At the end of the day, working capital loans can play a vital role in the growth of your business.  The key is to make sure you have picked the right loan to meet the needs of your business and to make sure you have a plan to pay off the loan.