Which Working Capital Loans Can Help You Bridge a Cash Flow Gap?
For small business owners, having access to enough money to help meet daily expenses, pay bills, and cover short-term operational costs is key. When businesses face a squeeze in their cash flow, many take out a working capital loan as a stop-gap.
Read on to find out what working capital loans are, the types of working capital loans that are available, and how they work. You’ll also find out what benefits working capital loans offer and where you can apply for one.
What Is Working Capital?
Working capital is essentially the amount of money you have available to meet your business needs.
To work out what working capital you have available, subtract your current liabilities (like your accounts payable and operating expenses) from your current assets (like your cash on hand and your accounts receivables).
If your company has a positive working cash flow, it has enough to cover its short-term obligations. A negative working capital suggests that you may be exposed to liquidity issues.
What Is a Working Capital Loan?
Entrepreneurs take out working capital loans to cover shortfalls in business cash flow. They use the funding to pay suppliers, cover payroll, or buy inventory.
Working capital loans are not intended for longer-term investments in expansion, real estate, equipment purchasing, or similar purposes.
Working capital loans are short-term loans. This means you pay them back over a much shorter period of time than other financing options, like traditional small business loans from a bank.
Why Are Working Capital Loans Important?
If you don’t have access to the cash you need to run your company in your business bank account, then you have to make a decision on who you pay and who you don’t.
If you choose not to pay your suppliers by the due date, you won’t get access to the products and services you need. You may be evicted from your premises if you can’t pay rent to your landlord on the agreed day. The repercussions are very serious if you don’t pay your staff on time.
Businesses suffer from cash flow issues for a number of reasons. One reason could be a temporary dip in sales, a spike in costs, or an unexpected bill.
Working capital loans allow your firm to work through these difficult periods by giving you access to the capital you need.
What Types of Working Capital Loans Are Available?
There are multiple funding options available for small business owners who need to borrow working capital. Here are some of the ones to consider:
1. Working Capital Advances
Working capital advances are a popular business financing option for company owners who need to cover a short-term cash flow gap. With this type of funding, you receive an upfront, lump-sum payment and then repay it in installments. The amount you can borrow will vary based on the lender and their application requirements, but you may be able to get between $10,000 and $2 million.
Backd’s working capital advances come with term lengths of up to 16 months with automatic daily, weekly, or semi-monthly repayments.
2. Business Lines of Credit
A business line of credit, sometimes called a working capital line of credit, functions in a similar way to a business credit card.
You get a withdrawal limit — that’s the maximum balance you can have at a given time. With Backd, you can receive a limit between $10,000 and $750,000. Every time you pay for something with your business line of credit, your balance goes up. Every time you make a repayment against the balance, it goes down, and you can borrow that money again.
The key advantage to a business line of credit is that you’re only charged interest on the money you use. For example, if you have a limit of $50,000, but you only ever withdraw $20,000, you won’t owe interest on the $30,000 you never used. This is unlike a traditional loan where you pay interest on the entire amount you borrow.
3. Merchant Cash Advances
Merchant cash advances (MCA) are advances against your future credit card sales. You receive the amount you’ve requested from your lender as a lump sum of cash.
Instead of interest, lenders charge a factor rate, which means that taking out an MCA can be very expensive. For example, a factor rate of 1.5 on a loan of $50,000 would mean you repay $75,000 in total.
To repay your loan, your lender takes a portion of the daily settlement you get from your payment processor (the company that handles your credit card payments) until the loan is repaid.
4. SBA loans
The Small Business Administration (SBA) loan program can provide business financing to help companies overcome cash flow issues.
You can use an SBA 7(a) loan for either short- or long-term working capital and have up to 10 years to repay the loan. You can’t, however, use the SBA 504 loan for working capital.
The SBA also offers a Microloan option for working capital. You can repay it in up to seven years.
5. Invoice Financing
Invoice financing, sometimes called invoice factoring, is a way of unlocking value from your unpaid invoices.
Whenever you issue an invoice, you forward it to your lender (known as a factorer). They then release up to 90% of the value of the invoice. You get the remainder minus the factorer’s fees when your client settles up.
What Are the Benefits of Working Capital Loans?
The seven main benefits of working capital loan options are:
Lower eligibility requirements: Many working capital loan providers will consider startups and businesses/owners with less-than-ideal credit scores. As a result, your loan application is more likely to be approved than with more traditional term loans.
Less paperwork: Unlike many types of business finance applications, you may not have to prepare a business plan, annual revenue statement, tax returns, and other documentation. This leaves you with more time to run your business.
Flexible usage: You can use the loan for virtually any purpose including hiring staff, purchasing inventory, and paying your day-to-day business expenses. Many other types of loans require you to use them for a specific reason.
No collateral required: You can apply for an unsecured working capital loan, meaning that you don’t have to risk losing your personal or business assets if your business fails and you cannot repay the loan.
Quick turnaround: Working capital loans are a great example of fast funding. Depending on the loan type and lender, you may be able to receive an approval decision within 24 hours. That’s far quicker than a standard bank loan.
Repayment flexibility: Many types of working capital loans, including working capital advances and MCAs, allow you to restructure the amount and/or timing of your repayments. This means you can pay less if you experience a downturn in sales.
Credit score building: If you’re on time with your repayments and your lender reports this activity to a credit bureau, you may see your personal or business credit score improve. This will make it easier to apply for loans in the future.
What Are the Drawbacks of Working Capital Loans?
Five drawbacks to this loan type are:
May be more expensive: As eligibility requirements on working capital loans are lower and many lenders don’t take collateral, you may pay higher interest rates than other loan types. Keep in mind that you’ll be paying for speed and flexibility.
Shorter time to repay: Since working capital loans are generally intended to be short-term loans, the repayment terms are often shorter as well. Because of this, it’s best to use a working capital loan to cover a cash flow gap with an end in sight.
Lower loan amounts: You won’t be able to borrow as much as you might be able to with a traditional loan because you have to repay the loan much faster. That makes working capital loans unsuitable for larger-scale business projects.
Personal guarantees: Even if your lender does not require collateral, they may require a personal guarantee. If your business fails and it owes the lender money, you become personally liable to repay the outstanding balance. Check with your lender about their terms and conditions.
How Do You Apply for a Working Capital Loan?
You can apply for a working capital loan at many banks, credit unions, brokers, alternative lenders, and online lenders that offer the loan types listed above.
To apply for working capital financing, follow these steps:
Consider how much you need: Work out how much funding you require and how you’ll use it to address your current or expected working capital needs.
Ready your application details: Although working capital loans do require less paperwork in general, gather together the details and numbers you may need to provide on the application form. This could include monthly revenue, your credit score, and your time in business.
Choose your lender: Scope out the market for potential lenders, checking to see how likely you are to pass their eligibility requirements.
Submit your application: Complete your lender’s application form and answer all of their questions. Many lenders now allow you to submit an online application.
Review your offer: If your lender approves your application, review their loan terms and conditions to make sure you’re happy with their offer.
Receive payment: Your lender will transfer the cash into the checking account you’ve specified or give you access to your business line of credit, depending on which loan type you chose.
Plug a Cash Flow Funding Gap With Backd
Working capital loans offer a valuable lifeline to companies that are struggling to meet their day-to-day expenses, either due to an unexpected downturn or expected seasonality. There are a variety of funding options available, so you can choose one that best meets your needs for loan amount, repayment terms, application requirements, and approval timeline.
Backd offers two leading products to help businesses cover their working capital needs:
Working capital advance: Receive up to $2 million with flexible repayment plans and term lengths of up to 16 months.
Business line of credit: Get a withdrawal limit of up to $750,000 with highly competitive rates.
Apply today and be funded in as little as 24 hours.
