Whether you’ve recently started a business or have been established for decades, cash flow problems can happen. This is especially true if your industry is cyclical or your business brings in the bulk of its revenue at a specific time of year. Fortunately, specialized business loans called working capital loans can help cover these gaps and help smooth out your cash flow.
Working capital loans are used to cover day-to-day operational costs. From an accounting standpoint, ‘working capital’ refers to your business’s current assets minus its liabilities. Current assets may include accounts receivable, cash and existing inventory. Current liabilities include payroll or vendor invoices you must pay within the following year.
Even if your business’s current assets substantially exceed its current liabilities, you may still need funds to cover current operational costs and other obligations. For example, if your company has $500,000 in outstanding accounts receivable and $250,000 in upcoming payroll expenses, your working capital is $250,000. But if payroll is due next week and your accounts receivables aren't due for a month, you’ll run into a cash flow issue.
A working capital loan can solve this problem. With this type of loan, you can borrow money using accounts receivables and other non-cash working capital if you need to meet obligations before funds come in.
Working capital loans aren’t for making big purchases, like buying business real estate or expensive equipment. Instead, these loans are used to cover the cost of things like payroll, rent, inventory or monthly debt payments. A working capital loan could help your business pay operational costs while you await customer payments.
Working capital loans may be secured or unsecured. A secured loan requires collateral or an asset that a lender can seize if you default. An unsecured loan only allows the lender to collect the amount owed.
If you opt for a secured working capital loan, your accounts receivable will serve as collateral. Your lender may get rights to your accounts receivable in general or particular invoices. As a loan condition, you’ll often need to link your payment processor or deposit accounts so your lender can withdraw loan payments automatically.
While secured working capital loans require collateral, they often have lower interest rates than unsecured working capital loans. You won’t need collateral with an unsecured loan, but this means a higher risk for your lender if you default.
Several types of working capital loans exist, each with a different structure. They can be secured or unsecured, depending on your lender's offer. Collateral requirements and borrower eligibility criteria vary by lender and loan type. The following are examples of working capital loans:
A term loan is a lump-sum business loan you pay back regularly with interest over a set repayment term. These loans may offer lower rates than other forms of business financing, and funds can be used for several purposes, including purchasing tangible business assets, hiring new employees, and more.
Term loan rates are typically fixed, though variable-rate loans may be available. You can often apply for a term loan online and, if approved, receive funding within a few days.
Those seeking flexible financing might find a business line of credit suits their needs well. You can borrow against a business line of credit up to an amount set by your lender, and you’ll only repay the amount you borrowed with interest. Business lines of credit can cover operational costs, such as payroll, inventory, or supplies.
Unlike term loans, which often have fixed rates, business lines of credit typically have variable rates, meaning your rate could fluctuate over time depending on market conditions and other factors.
Commercial loans generally come in several forms: term, business real estate and asset-based loans. Depending on the type of commercial loan you get, you can use the funds for things like expanding your business, acquisitions, capital improvements, consolidating debt and more. Rates for commercial loans may be fixed or variable, depending on your loan type and lender.
If you’re starting your business or are interested in expanding a Small Business Administration (SBA) loan could be worth considering. These loans are partially guaranteed by the SBA and issued by SBA-approved lenders. They offer several benefits, such as competitive rates and fees, various loan amounts, and secured and unsecured loan options. Borrowers can use their SBA loan funds for many purposes, including working capital, equipment purchases, renovations, etc.
SBA loans have their benefits, but they also have some drawbacks. Depending on the type of SBA loan you seek, you may need several years in business to qualify, a down payment may be required, and credit score requirements vary across lenders.
A working capital loan could be a good solution if your business is seasonal or your industry is cyclical, meaning your sales often align with broader economic performance.
For example, if you own a thriving clothing store with peak sales during November and December, a working capital loan could help smooth out cash flow during the summer or fall. Likewise, these loans can help businesses in cyclical industries that experience less demand during economic downturns, such as hotels, restaurants, construction companies, etc.
Working capital loans may also help your business recover from the unexpected, such as catastrophic weather or flooding.
Before proceeding with a working capital loan, business owners should assess their situation and determine if they truly need this type of short-term help or if another funding mechanism may be better. Depending on the length of the loan required, payment plan and interest rate options, some businesses may find other avenues for funding beneficial.
Business owners purchasing new equipment to improve their day-to-day operations might consider an equipment loan. These loans can be used to purchase various equipment, including an oven for their bakery, a backhoe for their landscaping company, a copy machine for their office, and more.
Equipment loans don’t require upfront collateral, as the equipment you purchase is your loan’s collateral. For instance, if you use an equipment loan to buy a new commercial vehicle, your lender could seize that asset if you default. These loans may also have more flexible qualification requirements than other types of business financing, but they often require a sizeable down payment.
Business credit cards are specifically designed for small business owners. They can cover various business expenses, including travel, office supplies, etc. Unlike a loan, a business credit card provides flexible access to a line of credit you can repay and tap into again when needed. Just ensure you repay your balance monthly to avoid high-interest charges.
Depending on which business credit card you choose, you may get benefits like a 0% introductory APR for several months, a valuable welcome offer, or the opportunity to earn cash back or travel rewards when you make purchases with your card.
Accounts receivable factoring involves selling a portion of your outstanding invoices to a third party, called a factoring company, for a discounted rate. In exchange, your business receives an advance, often up to 90% of the invoice amount, from the factoring company that you can use to cover short-term operating expenses. Once the invoices you’ve sold are repaid, the factoring company sends the remaining invoice amount minus any fees they charge.
This method of financing essentially involves getting an advance against your accounts receivables to cover your day-to-day costs.
The paperwork for a working capital loan is minimal, particularly for online lenders. Most financial institutions offering working capital loans consider credit rating and the number of years in business when approving applications. However, it’s a good idea to be prepared to provide additional information. This may include:
Many financial institutions and online lenders offer working capital loan applications online. Loan approval and funds disbursement are often available on the same day.
For more in-depth information on working capital loans and alternative financing options, review Seacoast's extensive range of business lending solutions. To explore further or apply for an SBA (small business) loan, head to our dedicated SBA lending section or get in touch with an SBA lender through the provided form below.
Topics: Financing
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