Are you looking to fund everyday expenses to run your business? You’re not alone. Many businesses struggle with cash flow and, from time-to-time, need an injection of working capital to cover operational expenses. That’s why there are working capital loans.
But if you’re wondering, “What is a working capital loan?” then you’ve come to the right place.
Here, we’ve broken down everything you need to know about working capital loans so you’ll never have to wonder, “what is a working capital loan,” again.
First thing’s first—before we dive into answering “what is a working capital loan,” it’s absolutely essential that you have an understanding of what working capital is.
It’s pretty simple. Working capital is the cash available to finance a company’s short-term operational needs, such as accounts payable, payroll, and other more immediate needs.
Working capital is essentially the difference between a company’s short-term assets and short-term liabilities, or the difference between what the the company owns and what it owes, in the short term. Usually month over month.
Another way to look at working capital: It represents the amount of cash a company has on hand to cover its operational expenses.
Obviously, access to working capital is important to fund operational expenses of your business day to day.
Having enough working capital will keep your doors open and fund your business’s growth, not only in the short term.
Not having enough working capital can have long-term negative effects.
If you don’t have access to working capital, you’ll have trouble paying short-term creditors back. And if your lack of working capital gets really bad, then it could lead to bankruptcy.
It’s important to catch low working capital before it gets out of hand. Low or negative working capital can be used as a red flag that something in your business needs to change:
If you’re wondering how you “catch” low or negative working capital, we’ve got you covered.
How do you know when you have enough working capital versus when you need to go out and find working capital? There are two ways to figure this out.
First, you need to know your business’s current assets and current liabilities. You can find these on your company’s balance sheet. Learn more about how to read your balance sheets here.
There’s a simple calculation to determine your business’s working capital:
Working Capital = Current Assets – Current Liabilities
This will result in a figure representing what you have in working capital.
You can also look at a working capital ratio to get a sense of whether you’re in the green or slipping to the red.
Your working capital ratio is calculated by dividing the business’s current assets by the business’s current liabilities.
If you get a number below 1, that means you have negative working capital. A ratio above 1, on the other hand, means that you have positive working capital.
Having a lot of positive working capital isn’t always a good thing, though. A working capital ratio above 2 could mean that you’re not properly investing your business’s assets.
So, having enough working capital is a matter of hitting the sweet spot: Anywhere between a 1.2 and 2.0 working capital ratio is a good sign.
Fortunately, if you find yourself in a situation with low or negative working capital at your business, that’s where working capital loans come in.
A working capital loan is a loan that has the purpose of financing the everyday operations of a company. Working capital loans are not used to buy long-term assets or investments.
The cash that you don’t have to cover your short-term obligations can be compensated with a working capital loan.
Working capital loans come in a few different products that fulfill different business needs or qualifications.
Due to the nature of a working capital loan, they’re typically structured as a short-term loan.
They can be exactly what a business needs to get a handle on covering operational expenses and making smart investments in the near term.
However, working capital loans aren’t always short-term loans.
They can also be any of the four following types of business loans:
Though challenging for most small business owners to qualify for, SBA loans are great options for working capital loans.
SBA loans tend to have lower rates, which is why they are tougher to qualify for. In most cases, they work just like regular term loans, or installment loans, but have government backing to reduce the amount of risk for the lender.
There are a few types of SBA loans that might work for working capital needs.
Business lines of credit also make great working capital financing options in part because of their flexibility.
A working capital line of credit is any line of credit that a business acquires for the purpose of working capital rather than for the purpose of investing in one specific purchase.
So, if you need a line of credit to help with your day-to-day cash flow, to aid you in paying your employees, or to cover miscellaneous maintenance costs, to name a few examples, then this would be considered a working capital line of credit.
With a working capital line of credit, you get access to a pool of funds that you can tap whenever you want or need to for your business.
You only pay interest on the funds you draw from your credit line. And once you’ve repaid what you drew, your credit line gets refilled to its original amount.
Because the funds sit there in your back pocket until you need them, working capital lines of credit are great for covering cash flow issues as they come up—you only pay for what you use.
Here’s what else you need to know about working capital lines of credit.
A merchant cash advance (MCA) is a lump sum of capital you repay using a portion of your daily credit card transactions + factor fees.
MCAs are suitable for a wide range of business purposes, making them a great option for working capital needs.
A merchant cash advance is a quick, easy way to get a business cash advance with no need for collateral—even if you don’t have a great credit score. MCAs are one of the easiest financing options to qualify for if you use credit card transactions as part of your revenue.
Here’s what you need to know about merchant cash advances:
Knowing where your business stands in terms of working capital is important for both short- and long-term business growth.
But if you find yourself at risk of low or negative working capital, you can, fortunately, find many solutions in terms of working capital loans.
Hopefully, you now have a strong understanding of “what is a working capital loan,” and can find the right working capital loan for your business today!