Everything You Need To Know:
What Are Working Capital Loans? Working Capital Loans For Small Businesses
A working capital loan is a form of business finance that is used to cover a business’s everyday expenses and operations. Unlike other loans, they are not used to buy long-term assets or cover long-term growth investments. Instead they fund day to day costs, and provide working capital for the short-term.
Working capital loans are short-term business loans, which means businesses typically borrow the money over a 12 month period.
What Is Working Capital?
Working capital is defined as the amount of money a business can safely spend to cover daily operations. Also known as net working capital (NWC), it is the difference between a business’s current assets and liabilities. It is used to measure a business’s liquidity and short-term financial growth. Without considerable working capital, a business will be hard pushed to invest and grow.
On a business’s balance sheet, current assets listed include:
- Accounts receivable (unpaid bills)
- Assets expected to be liquidated in less than a year
Whereas current liabilities comprise:
- Accounts payable
- Taxes payable
- Current long-term debts
When a business’s current assets don’t exceed its current liabilities, it can be difficult to achieve growth, and may even be at risk of bankruptcy.
Working Capital Loans For Small Business
According to Startups, just under 30% of all new startups in the UK fail due to insufficient working capital.
Lack of working capital can make it particularly hard for small businesses to attract funding from investors and business credit lenders. Analysis of a business’s working capital can provide insight into how well the company manages its finances, and can often pose a business as higher risk in the eyes of a lender.
Certain businesses require more working capital for their operations to run smoothly. Businesses that have a lot of physical inventory are an example of this, as are those in retail, wholesale and manufacturing. As well as these industries, seasonal small businesses tend to need high working capital for parts of the year they are at their busiest.
The length of a business’s operating cycle can also impact working capital. In an ideal world, a business can pay off short-term expenses with revenue from its business sales. Where a business takes longer to create and sell products, working capital is required to cover costs incurred in the interim.
Small businesses usually look to expand and grow as time goes on. These small businesses will need far higher levels of working capital than those looking to stay small. This is where working capital loans for small business can help fund additional working capital necessities.
Working Capital Uses Advantages & Disadvantages
As mentioned previously, working capital is crucial to a business’s success. Without it, it can be a struggle to undertake the normal activities and operations that are essential for staying in business. All businesses experience shortfall from time to time, which is why working capital loans have been designed to meet the needs to these every day costs.
10 Ways To Use Working Capital Loans
- Manage cash flow
- Bridge delayed payments
- Make purchases
- Repairs, updates and upgrades
- Cover seasonal shortfalls
- Unexpected expenses
- Sufficient inventory
- Daily Operations (finance salaries, inventory purchases, equipment needs, unforeseen emergencies)
Advantages Of Working Capital Loans
Access Finance Fast > Because working capital loans are a form of short-term financing, it is quicker to get approved. This means businesses can access working capital in their account in just 48 hours.
No collateral required > working capital loans are known for requiring very little to no collateral when taking out the loan, this means that businesses assets aren’t put at risk.
Short repayment period > Because the money loaned is designed for the short-term, businesses benefit from shorter repayment periods, usually lasting under or up to 1 year. This means that businesses can repay the loan quickly, avoiding having to make repayments with interest for years and years.
Disadvantages Of Working Capital Loans
Higher interest rates > working capital loan terms typically have higher interest rates than traditional long-term loans. Businesses should ensure that this is a risk worth taking, to avoid being tied up in repayments with hefty interest.
Working Capital Finance The Different Funding Options
There are different types of working capital financing available to businesses. Business owners should select a product dependant on their industry and individual circumstances.
Working Capital Loans
Unsecured working capital loans allow business owners to receive a loaned amount of money which they receive in full upfront, paying it back with interest in scheduled monthly payments over a pre-agreed repayment period. Businesses can typically receive funding up to £500,000, and as the loans are unsecured, no security needs to be offered to the lender through collateral.
With working capital loans, its likely that a business owner will be asked to give a personal guarantee. This personal guarantee exists to ensure that if the business defaults on loan repayments, the director becomes personally responsible for paying back the funds.
Merchant Cash Advance
A merchant cash advance is another type of finance that provides as a great way to increase working capital. It’s called a ‘merchant cash advance’ because it’s a funding option for merchants: businesses such as retailers, pubs, cafés, restaurants etc.
Unlike loans, a cash advance is an advance on the revenue a business is predicted to generate through its future debit card and credit card sales. Businesses that take regular card payments can benefit from a merchant cash advance, and because businesses only pay back a percentage of their earnings, the repayments are nicely in sync with cash flow.
Working Capital Loans For Business With Bad Credit
A business with bad credit can be limited in its options for working capital finance. Where a lender sees that a business has had issues repaying past debts, it’s likely they’ll view the business as high risk. Credit scores can impact the overall rate charged, to reflect the additional risk. Alternatively, some lenders may ask for a guarantor, despite the loan being unsecured.