A Quick Guide to Working Capital Loans

Working capital loans

Whether it’s a coffee shop you own or a hair salon, or any other small business, there’s one thing you’ll always need- A steady flow of working capital. This is the lifeblood of a healthy business. Adequate working capital is crucial for many reasons. It helps you handle your business’s short-term financial needs including invoice payments, payroll, inventory purchase, or even electricity bills. And when the cash flow is not sufficient to handle these expenses, a working capital loan is what you need.

What is a working capital loan?

This is a loan you can take out to pay for your business’s everyday operations. This loan helps you meet your company’s day-to-day expenses and gives you the flexibility to invest in its growth. A working capital loan is typically a short-term loan and is not used for making large investments or purchases.

When is working capital loan most useful?

This loan comes in handy in a variety of situations. For instance, if you own a retail store and need to hire temporary staff to meet the sales rush for an upcoming holiday, this loan helps you cover the cost of hiring and training employees without draining your reserves.

Similarly, you can use this loan to keep your business’s insurance coverage up to date or to pay for inventory purchases when you’re short on cash.

This loan is also very useful when your business is a bit slow and you want to launch an ad campaign or revamp your marketing strategy.

If your business has cyclical/seasonal sales, then a working capital loan helps you pay for the operating expenses during the quiet period.

What are the types of working capital loans?

Some of the types of these loans currently available in the market are:

  • Short- term loans, where you are given a lump sum which you can repay over a short period of time, typically from 3 to 18 months
  • Revolving lines of credit, where you get access to a pool of funds that you can tap into whenever you need capital
  • Merchant cash advances, where you get a sum as cash advance, which you repay by allowing the merchant company to take a fixed percentage of your daily credit card sales
  • Invoice factoring, where you sell your open invoices to a third party in exchange for an amount
  • SBA (Small Business Administration) guaranteed loans, which can be availed from lenders, community development organizations, and micro-lending institutions.
Why you should or should not opt for a working capital loan?
Pros Cons
A working capital loan is quick and easy to obtain and helps you efficiently cover working capital expenses. You should have a high credit rating to qualify for an unsecured working capital loan.
It is a form of debt financing and requires no equity transaction. So you remain in full control of your business. This loan is tied to your personal credit. So any defaults or missed payments are likely to pull down your credit score.
Unsecured working capital loans do not require you to put down any collateral. Interest rates are often high to compensate lenders for the risk.

Without a steady flow of working capital, your inventory gets delayed, your employees, invoices, and utility bills go unpaid, and consequently, your business suffers. That’s the reason why it’s important that you function with positive working capital. And a working capital loan is the best way to ensure that your business operations run smoothly.