What is a working capital loan?

What is a working capital loan

 

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What is a working capital loan? As a financing option, these loans furnish businesses with the essential backing needed for day-to-day management. Importantly, they do so without jeopardizing the long-term financial health of the business.

Even with stable financial performance, many small businesses find themselves in need of additional financial support at one time or another.

“Working capital loans provide not just a lifeline but a strategic tool for smoothing out cash flow fluctuations, making sure that businesses can continue to innovate, grow, and compete without missing a beat in their operational commitments,” said Credibly Founder Ryan Rosett.

In this blog post, we’ll define working capital loans, explain how they work, go into the pros and cons, and explore the types of working capital loans and some alternative options.

 

What is a working capital loan?

A working capital loan is a financing option designed to help businesses manage their daily operations. This type of loan provides companies with the necessary funds to cover short-term expenses such as payroll, rent, and debt payments.

Tip: It’s important to note that working capital loans are not intended for purchasing long-term assets or investments. Instead, their main purpose is to ensure that a business maintains a healthy cash flow, helping you run day-to-day activities without financial hiccups.

Working capital loans are known for quick funding and short repayment terms, making them an ideal solution for businesses needing immediate financial support to sustain operations.

While some financial products are exclusively categorized as working capital loans, other options like term loans and business lines of credit can also fulfill this role. These loans are a great solution for businesses looking to bridge gaps in cash flow.

How do working capital loans work?

When a business obtains a working capital loan, it receives a lump-sum amount upfront. This amount is then repaid over a specified term, along with interest.

The repayment structure of these loans is flexible, with terms ranging from daily to weekly (or monthly) payments.

Pros and cons of working capital loans

These loans have several advantages but also come with potential drawbacks that you should consider before applying.

Pros

  • Flexibility: These loans provide financial versatility, helping businesses to use the funds for a wide range of needs such as payroll, inventory, and other operational expenses. As we discussed earlier, this flexibility helps you address immediate financial requirements without limitations.
  • Keep control of your business: Working capital loans help you secure financing without surrendering equity—a significant advantage for those looking to maintain decision-making power and future profit shares.
  • Lower credit limit required. When you’re looking at financing options you could qualify for, working capital loans have a lower credit limit requirement.
  • Fast application process: The process to apply and receive a working capital loan is usually quick and straightforward. This speed can be critical if you’re facing urgent financial needs.

Cons

  • Interest costs: Working capital loans may come with higher interest rates compared to secured or longer-term financing options. These costs can impact the overall profitability of the business, especially if you don’t manage the loan carefully.
  • Short repayment terms: The repayment period for these loans typically ranges from 3 to 18 months. (Terms and loan sizes will vary by lender.) Such short terms can strain your cash flow, especially if your operational revenues do not increase as anticipated.
  • Limited loan amounts: Depending on your business’s financial health and your lender’s policies, the amount available through a working capital loan may not be enough to cover major investment needs. As a result, you could need additional financing solutions for larger projects or expansions.

Learn more about your business financing options:

Unsecured vs secured working capital loans

Unsecured working capital loans, which don’t demand collateral, are based off the credit rating of a business. A higher credit score often translates into better loan terms, as it signals to lenders that the business poses a lower risk.

For secured working capital loans, collateral is required. This collateral can range from business assets to other valuable items. While offering collateral can make it easier to obtain a loan and possibly at a lower interest rate, there’s a significant risk involved. Failure to meet repayment obligations could result in the loss of the collateral.

Types of working capital loans

These loans come in various forms, each with unique features and benefits, catering to different business needs.

Line of credit

This is a flexible option that gives businesses access to a predetermined amount of funds, which can be drawn upon as needed. This is particularly useful for managing recurring cash flow shortages and unexpected expenses.

Small Business Administration (SBA) 7(a) loan

These government-backed loans are designed for businesses that may lack collateral or have limited credit history, offering up to $5 million with favorable terms and capped interest rates. However, they can take up to 90 days for approval.

Alternatives to working capital loans

Beyond these options, businesses might consider long-term business loans for more substantial purchases that require longer repayment terms and come with stricter underwriting standards.

Invoice factoring

Businesses can borrow against the value of their unpaid invoices with this option. It features fast online processing and the possibility of next-day funding, making it an excellent choice for businesses that need to bridge the gap between billing cycles.

Business grants

Business grants are another alternative, offering funds that don’t need to be repaid. Grants often target a specific demographic or sector, making this option highly competitive at times..

While these options can offer significant benefits, they might not suit every business’s immediate financial needs. The flexibility and speed of working capital loans can be crucial in supporting your business’s success.

What is a working capital loan? Your key to business success

Don’t let funding hurdles slow you down. Discover if a working capital loan is right for you and access the capital you need in as fast as 24 hours.

With over $2B funded to more than 30,000 businesses, we stand out in providing working capital loans that fits the way you do business.

Let’s get started.

Speak with a finance expert today.

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