Understanding Working Capital Loans For Small Businesses

You can use working capital loans to pay for your small business operational costs, such as rent, payroll and debt payments. They give you the flexibility to invest your company’s growth while covering everyday expenses.

If you have an established business with a steady cash flow, reach out to a bank as they offer the lowest financing rates. However, if you experience problems with cash flow, you can turn to traditional and alternative financial institutions to meet your funding needs. Some of these options include a term loan, a business line of credit or invoice factoring. You may also use business credit cards and earn rewards in the process.

In this guide, we’ll cover exactly how a working capital loan functions, and where to find the best options for your business.

Small Business Working Capital Loan
Small Business Working Capital Loan

What Is A Working Capital Loan?

The most common type of working capital loan is a short-term working capital loan. It can be only a few thousands of dollars since it depends on your operational costs. Repayment schedule varies in frequency depending on the lender.

If you have substantial credit card sales, you should consider a merchant cash advance. This working capital loan provides a lump sum for a percentage of daily card sales until you pay back the balance. You can calculate the amount based on how much debt and credit transactions you are plan over a certain time. You will deduct payments when you make sales to avoid impacting your cash flow negatively.

You could also consider accounts receivable factoring, especially if you have unpaid receivables or invoices. The lender may purchase outstanding receivables for a discount, and the borrower will receive the money immediately. The lender then collects the payment from the customer. Once you raise the amount, the borrower gets whatever is outstanding from the first payment, minus a percentage.

Why Do I Need A Working Capital Loan?

Short-term working capital loans are great for cash shortages or short-term investments. If you are short on cash, you’ll get a loan if it is temporary and beyond your control. Short-term working capital loans also allow you to handle unplanned projects that require operational funding. It allows smaller businesses to accept profitable and long-term plans since they can wait until the completion of the project to pay their bills and employees.

You may also get a merchant cash advance for medium term projects such as a marketing campaign, a purchase of new equipment, bulk inventory purchase, or seasonal hires. You can use merchant cash advances when business is slow to help out long-term investments and then pay it back when revenue increases.

Accounts receivable factoring stabilises your cash flow when you have pending payments from clients or customers. Instead of waiting over a month for refund, you get paid immediately after the purchase of the receivables. The borrower may use the money for anything. You may use accounts receivable factoring to sign a deal with a new client that you usually could not afford because of delayed compensation.

5 Reasons to Seek Out Working Capital Loans For A Small Business

Unlike most small business loans, you can use working capital loans for running costs.

Your working capital consists of assets that you can convert into cash within 12 months, minus your due liabilities within 12 months. This is the money you have left over after you’ve worked out how much you’ve made and how much you need to pay out. Payroll, rent, and utilities all of them come out of working capital.

Your company will go well if you have a positive working capital, and working capital loans will be one way to ensure that this is the case.

Here are five general ways that you can put working capital loans to work for your small business:

  1. Handle Downtime
    Every business experiences downtime every now and again, especially seasonal businesses. For example, you may make a significant portion of your sales during the holiday season or warm summer months. It is a must to have enough working capital to get by during the other times of the year.
  2. For Growth and Expansion
    Are you ready to take your company to the next level? Is expansion on your mind? With working capital, you’re in a position to act fast. The same can’t be said if you’re in the place of negative working capital. It can work against you when you’re trying to grow.
  3. Prepare for an Emergency
    Just like with your finances, you need to prepare your company for an emergency. What will happen if you lose your most important clients? What if you face a lawsuit? It can significantly impact your financial situation. When you have working capital, you can handle anything that comes up – without having to scramble to find the necessary funds.
  4. To Pay Short-term Debt Obligations
    Short-term debt is a way of life for many companies. You need enough working capital to handle this as it happens.
  5. Peace of Mind
    With no working capital, you’re always at risk. Even something small could cause severe financial damage. For your peace of mind, do your best to have access to enough working capital at all times.

Working Capital Loan Case Studies

Here are some general examples of how you can put a working capital loan to work for your business.:

  • The Big Opportunity
    Imagine you run a custom made guitar business.
    You have $7,000 of assets and $4,000 of liabilities (debt). That gives you $3,000 in working capital.
    So why would you want a working capital loan?
    Let’s say you usually get ten orders per month. Your $3,000 is more than enough to pay suppliers and payroll to make ten guitars.
    However, what happens when an important store contacts you and wants 30 orders for next month? That’s a lot of business for you, but your $3,000 of working capital isn’t enough to cover the cost of materials and increase in payroll to fulfill the order.
    So you take out a working capital loan. It covers the cost of the materials and overtime expenses for your staff. You fulfill the order and even with the fee for the loan, make an excellent profit.
    Without a working capital loan, you wouldn’t be capable of accepting such a large order and your business would suffer.
  • The Seasonal Business
    Another example is if you run a seasonal business and have pre-season costs but no pre-season revenue. If you’re setting up shop during spring, and you have to make some repairs, you’ll have to access some form of working capital that you probably don’t have from the winter.
    A working capital loan will give you the money you need to cover your repairs and set up shop before the business starts pouring in during your summer upswing.

Different Types of Working Capital Loans

In a perfect world, you’ll be able to increase working capital by generating more revenue.
Unfortunately, this isn’t the way things work for every company. Some have to think outside the box, like seek working capital loans for small business through other means.
Your options include:

  • Working Capital Short-term Loans
    Usually, you will seek a short-term loan and you will receive a lump sum loan that you can pay back over a shorter period (3 to 18 months).
  • Working Capital Lines of Credit
    It is a very flexible option for small business owners. You may use it as a backup plan when your cash flow is negative. If approved, you can tap into a pool of funds whenever you need to.
  • Merchant Cash Advances
    A merchant cash advance is a quick and easy option. You can get a sum of cash, which you’ll pay back with a fixed percentage of your daily credit card sales. While this is a smooth working capital solution, it’s the most expensive to get.
    You can access a working capital loan from AMEX through American Express Merchant Financing. You’ll receive a lump sum of cash from AMEX of anywhere from $5,000 to $2 million, and repay it, plus a set fee (rather than interest), through a percentage of your credit and debit card transactions.
    The fees attached to your merchant financing can be as low as 3% of your loan amount and as high as 28% of your loan amount. So how affordable this working capital loan ends up being can vary.
    That said, if you think that merchant cash advance offers an ideal setup for your business, but you want to access a cheaper loan, then American Express Merchant Financing could be the best option.
  • SBA Loan
    An SBA loan is the most popular working capital loan. The 7(a) credit works offers anywhere from $5,000 to $5 million to use for different business reasons.
  • Invoice Financing
    If your working capital is tied up by late customer payments, then invoice financing helps you get paid immediately for your outstanding accounts. This frees up cash to use for your business’s daily operations.

Working capital loans for everyday needs

A working capital loan can help your business cope with seasonal decreases in revenue, cover maintenance costs and salaries or manage your assets.

  • If your credit score is between 500-600:
    Kabbage gives you a fast working-capital line of credit up to $150,000. It’s a good option if you have poor credit and need quick cash; however APRs can reach 99%.
  • If your credit score is above 600:
    StreetShares (peer-to-peer lender) offers lines of credit and term loans to businesses making at least $75,000 a year. It’s a good option if your revenues are low, but you can borrow only up to 20% of your annual income.
  • If you need more than $100,000 for your business:
    Take out a term loan with OnDeck up to $500,000, but you should have a credit score of 660 or higher. However, APRs can reach 99.4%. You can get approval in as soon as 24 hours. The fees will depend on your cash flow and credit rating. It is an excellent option for businesses that are more established and have more revenue than new companies.
  • Credit Cards for everyday needs
    You can finance every day needs with a business credit card which helps you build your credit and earn rewards, such as cash back or travel miles. You will typically require a proper personal credit to qualify. Credit limits generally are lower than a business line or line of credit.

Working capital loans for large purchases

If you need a hefty sum to cover expansions or equipment purchase, look for online lenders that offer low APRs and better reimbursement terms.

  • For lowest rates and most extended repayment period
    SmartBiz gives Small Business Administration loans to established businesses with the lowest APRs on the market and a 10-year repayment term. But the application process is laborious, and funding may take up to several weeks and not just a few days like other options.
  • For purchasing equipment
    Currency Capital can provide loans up to $2 million. Borrowers can find equipment lenders here, and some of them charge a prepayment penalty.
  • For quick funding and competitive rates:
    Credibility Capital provides loans of up to $350,000, and you can get funding in less than a week, but the term length is only three years.

Working capital loans for unpaid customer invoices

Companies in the business-to-business sector will face gaps in cash flow. Invoice financing is a good option in this case, but high APRs make this type of borrowing pricey.

  • If you have customers with a strong-credit score:
    BlueVine can provide up to $5 million even if you have poor credit or if your business is only a year old. It’s an excellent way to benefit from a customer’s strong credit score, but if your customer doesn’t pay you, you’re liable for the loan. The terms will vary based on the loan you choose. It’s a good way to access short-term financing to boost your small business working capital.
  • For businesses with bad credit:
    Fundbox can give you access to cash in less than three business days. You don’t need a minimum revenue or personal credit score to qualify, but you need to use accounting software like QuickBooks.

Working Capital Loans for Bad Credit

If your credit score is bad, you may still get a working capital loan for your business. Here are some of the best lenders and you do not require a minimum credit score to apply.

  • Kabbage
    Kabbage is an excellent option as they don’t have strict rules to qualify. Your business has to be operational for one year and generate $50,000 in revenue yearly to be eligible for up to $100,000. If you’ve been in business for more than three years and have at least $500,000 in annual revenue, you can get lines up to $150,000. Your business’s online information, including your banking, social media, and vendor accounts, will be evaluated, so if you don’t have a good credit score but your business is financially healthy, you may get a substantial loan amount. You may get up to $150,000 with a six- or 12-month term, and you will receive the funds in one to three business days in your bank account and one on the same day to a PayPal account.
  • PayPal Working Capital
    If you use PayPal to process most of your sales, you may seek a PayPal Working Capital loan. One of the requirements is to be using a PayPal business or premier account for at least three months, and be generating between $15,000 to $20,000 in yearly sales through PayPal. You may get up to 18% of your purchases in the past year, up to a maximum of $97,000. Once approved, you can get funds immediately to your PayPal account.
    You will repay a fixed percentage of your daily sales on PayPal with automatic repayment. There is no lump-sum payment every month. When you have slower sales days, you will contribute less to your loan repayment. There are no particular terms; instead, you must pay back your loan within 18 months. APRs are between 15% to 30%, which is not as high as other lenders mentioned in this article.
  • FundBox
    Fundbox provides invoice financing and lines of credit up to $100,000. You don’t need a specific credit score to qualify, but you have to be operational for at least 2 or 3 months and generate some revenue (more than $25,000 for a line of credit and some income if you apply for invoice financing over $30,000). It offers APRs that range from 15% to 59% for a line of credit and 13% to 60% for invoice financing.
    You don’t need a separate account for your customers to pay the factoring company. When you pay an unpaid invoice, you’ll receive a 100% advance on the invoice, and you have to repay this plus fees over 12 or 24 weeks. To use Fundbox, you’ll need to use available accounting software, such as QuickBooks Online and Desktop, Harvest, PayPal, FreshBooks, Xero and Clio.
  • Credibly
    If you need a short-term loan, Credibly provides affordable working capital loans with low APRs and high loan amounts. You don’t require a credit score, personal guarantee or collateral. It is an excellent choice if you need an unsecured loan up to $250,000. To qualify, you need to be operational for six months with $10,000 in monthly revenues and bank deposits. APRs are lower than other lenders and range from 10 to 36%. If approved, you can receive funds in as soon as 48 hours.

Best Working Capital Loans for Good Credit

If you have good to excellent credit scores, you may seek affordable working capital loans and lines of credit from banks and credit unions.

  • SBA CAPLines
    The SBA offers an excellent line of credit program that lets you borrow up to $5 million with low interest rates. SBA CAPLines allows you to borrow money for working capital needs with up to 85% of the loan guaranteed by the SBA with the same interest rates as with a standard 7(a) credit. They have very competitive rates from 6 to 8% and comes with terms up to 10 years. It’s a great long-term option. You may apply through a bank or credit union.

    • Lines up to $5 million
    • Funds in several weeks to months
    • Stricter eligibility requirements
    • Bank Loan or Line of Credit
    • 6.00% – 8.50% interest rates (maybe lower)
    • Terms of up to 10 years
  • Bank Loan or Line of Credit
    If you already have a banking or borrowing relationship in a bank, check out standard term loans and lines of credit for small businesses. You will need a strong personal and business credit scores. You will enjoy some of the lowest APRs and competitive terms. You may borrow up to several million dollars and with terms over five to 25 years. Funding may take a few weeks, but some banks have started offering online loans with approval in a few days.

    • Terms up to 5 to 25 years
    • Funds in several weeks to months
    • Strict eligibility requirements
    • Low APRs
    • Loans up to several million

Best Working Capital Loans for Startups

  • SBA
    The SBA offers the Community Advantage loan for underserved and new businesses. You may borrow up to $250,000 for working capital or other needs with an interest rate capped at 9.75%. You’ll also have assistance and services for your business, including marketing, payroll, accounting, and business plan preparation.
  • Kiva
    Kiva offers working capital startup loans if you don’t have a good credit score, up to $10,000 with no interest. You’ll need to be based in the U.S., be at least 18 years old, have a PayPal account and not a bankrupt. You’ll also need to provide a compelling pitch to convince potential lenders. Typically, your loan will depend on how old your startup is. At the conceptual stage, you can get up to $1,000. If you’ve been operational for less than 90 days, you can get up to $5,000. And if you’re generating revenue, you can get up to $10,000.

    • Terms up to 3 years
    • Funds in 6 weeks
    • 0% interest rates
    • Loans up to $10,000

What You Need to Consider When Getting a Working Capital Loan

If you need to cover unpredictable expenses and gaps in your cash flow, you can consider a working capital loan. If your business has a seasonal business cycle, you may take advantage of this type of loan during months with lower sales to consider your daily expenses. During the busy season, you will be able to purchase more inventory and hire more staff. You may also choose this type of loan when you need extra funds to expand or start new projects.
Choosing a bank or an online lender will depend on a few factors. Borrowers who want an online lender will receive funds within a few days and don’t need to pay back the loan over a few years. Some repayment options will allow you to be debt-free in just a few weeks and you may use the loan for a different reasons. However, the APRs will be higher, and you’ll have less time to generate cash to repay the short-term loan. Banks can provide more top lines of credit with better terms, so they are an excellent option for an established business with higher running costs. However, banks have a more complex process and stricter terms and requirements.

How to Evaluate Small Business Loans

You should compare all of your options using the APR, which is the actual cost of the credit and includes all fees. NerdWallet has a small business loan tool with options such as customer experience, market scope and lender trustworthiness.

What Documents Will I Need To Apply For Working Capital Loans

  • Driver’s License
  • Voided Business Check
  • Bank Statements
  • Credit Score
  • Business Tax Returns
  • Credit Card Processing Statements

Monitoring Your Working Capital Finances

Here are three steps to monitor your working capital:

  1. Keep a running tally of your assets.
    Your assets will change regularly, so you need a system that lets you stay on track.
  2. Keep track of your liabilities too.
    You need to know your liabilities, including the total debt, monthly obligations, and when you can expect your debt to be paid off.
  3. Know the number that will keep your business operating efficiently.
    If you get close to a critically low level for your “cutoff point”, it’s time to reassess your situation and make changes that will work in favor of your organisation. As complicated as this may sound, it all comes down to regular monitoring.

Final Thoughts on Working Capital Loans

There are many uses for working capital loans in a healthy small business. But just like any other types of loans, it’s essential that you look closely at the costs and fees associated with working capital loans.

Because of their fast approval process, and they frequently are unsecured. Working capital loans often come with substantial APRs, so get a couple of different quotations to get the best rate possible.

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