It would be comforting to think that as your business grows you will never face the need for a small business loan. But even successful businesses hit financial speed bumps, and there comes a time when every business owner finds himself or herself short of cash and unable to meet day-to-day operational expenses.
This is not necessarily a reflection on your business acumen or overall management skills. As any experienced business owner will tell you, the unexpected is always just around the corner. Cash flow can suddenly tighten up. Season sales fluctuations can put an unexpected strain on your operating budget. Sudden repairs or maintenance costs can push your on-hand working capital to its limit.
In short, stuff happens and when it does you may find yourself in need of a working capital loan to tide your business over until the cash flow returns to normal.
What is Working Capital?
Working capital is simply the difference between a company’s current assets and its current financial liabilities. In everyday terms it is the amount of money you have on hand to cover your business’ immediate expenses. A company’s net working capital figure will naturally fluctuate over time, and even a healthy company is likely to run into patches where that figure falls into a negative balance. It’s at times like these, where there is not enough working capital to manage everyday operating costs, that a small business loan may be necessary.
What are Working Capital Loans?
Working capital loans (also known as operating capital loans) are short-term loans that can be used to pay for a business’ everyday operating expenses. These loans are not to be used for investments or for the purchase of long-term assets. Typically, a working capital loan is used to cover a company’s short-term operational costs such as payroll, inventory, or rental costs.
The most common types of working capital loans include term loans, credit lines, and invoice financing. As with all financing products eligibility for a working capital loan is largely dependent on the business’ credit history, collateral, and perceived ability to repay the loan.
Pros and Cons of Working Capital Loans
Working capital loans, like most financial products, have their pros and cons. In the plus column is the easy availability of these loans for small businesses with strong credit histories. A business with a good or better credit rating is likely to be able to secure their loan without the need for collateral. Moreover, because these are short-term loans with quick turnarounds the approval process is streamlined and fund can be made available in short order.
Another significant benefit of working capital loans is that they are a form of debt financing. This is an important consideration for small business owners, because it means that they will maintain full control of their company. Even if the financial need is desperate, the lender will have not controlling interest in the business.
However, there are a couple of drawbacks to a working capital loan that business owners should be aware of before they sign any binding agreements. First, because these are short-term loans interest rates tend to be higher than other small business loans. This is particularly true of your credit history is less than stellar. It is also important to note that working capital loans are typically tied to the business owner’s personal credit. In the event of missed payments or a default on the loan it is the owner’s credit rating that will take the hit.
7 Most Common Uses for Working Capital Loans
There are as many different uses for a working capital loan as there are reasons for needing one. One of the distinct advantages of these types of loans is that the funds can be applied to just about any business expenditure. They can be used to pay off debt, expand your business, or simply cover everyday operating costs until your cash flow returns to normal.
It’s that kind of flexibility that makes these types of loans so attractive, and frankly invaluable, to small businesses dealing with inconsistent revenue streams. The right working capital loan can help get you over any potential financial bumps in the road, and keep your business ticking along nicely throughout the fiscal year.
So, let’s look at some of the most common uses for a working capital loan.
1 – Inventory Purchases
Retailers need to keep inventory stocks active and on point in order to be well prepared for peak sales times. Unfortunately, to make that happen orders often have to be placed when the retailer’s sales are slow and overall revenue is down. A working capital loan allows small retailers to maintain all-important stock levels in the face of a negative working capital figure.
2 – Equipment Purchases and Repairs
Smaller independent manufacturers often need to purchase new equipment in order to increase their output and meet production quotas and boost revenue. Working capital loans make it possible for smaller enterprises to purchase the equipment they need to increase production without having to wait on an uptick in B2B orders to fund their projects. A short-term operating capital loan can fund the purchase of new equipment, which results in greater productivity and increased revenues, which can be used to repay the loan.
Working capital loans are also often used to cover unexpected equipment repairs and upgrades that might not otherwise be possible without immediate funding. Again, the repairs and upgrades allow the company to advance production quotas, thereby increasing revenue and offsetting the cost of the loan itself.
3- Business Expansion
Start-ups often experience growing pains, in which business is on an upswing and the opportunity for expansion is clear. However, current revenue streams can’t support the necessary expansion. Without additional funding lucrative opportunities may be lost. A timely working capital loan can help support the business’ expansion despite the company’s modest on-hand cash reserves. Such a loan might be used to open a new location, branch out into a new product line, or expand into supplemental markets.
4 – New Hires and Employee Training
As small businesses grow, it soon becomes necessary to hire new employees to support the ongoing development. Those employees will help to expand the business and bring in added revenue, but they must be brought onboard and trained first. That requires an outlay of funds that may not be readily available at the time. A working capital loan is often the answer to the conundrum. Business owners can use the funds provided by the loan to bring in and train new employees, whose future performance will bring in the revenue needed to pay off the loan.
5 – Meet Payroll Obligations
Part of keeping a solid cash reserve for any business is ensuring that there is enough money available to pay all employees on time and in full. Ideally, every business (regardless of size or industry) should have at least 6 months worth of cash held in reserve to cover basic operating costs. That means there should be ample funds on hand to cover, at minimum, 6 months of employee payroll.
Understandably, when sales are sluggish or when businesses move into their off-season, this can become increasingly difficult to maintain. In those instances a well-timed operating capital loan can help bridge the gap and keep employee payroll up to date.
This is one of the most important uses of a working capital loan. Employees are the backbone of every business. If your employees are not being paid on time they are going to look for another position and, frankly, their performance isn’t going to be too spectacular while their searching for other means of employment.
6 – General Business Expenses
Often, it’s the little things that can create the most havoc. Office supplies, computer software, trash removal, water and electricity – these are all an integral part of keeping any business up and running. It’s these day-to-day expenses that often get overshadowed by the large-ticket purchases and the high cost expansion projects. But when capital is strained it’s important to stay current with these ever day expenses, or risk a drop in productivity across the board. This is exactly what working capital loans were designed to address, and the funding they provides allow business owners to keep their company rolling even when cash reserves are low.
7 – The Unexpected
It’s one thing to expect the unexpected, but it’s another to be prepared. Equipment breaks down, company vehicles need repairs, and natural disasters upend all of your business plans in one fell swoop. Financial emergencies can, and do, happen every day and more often than not there simply isn’t enough money on hand to cover the expenses and keep your business running smoothly. Still, the unexpected must be met and dealt with or you must surrender to events and let your company’s performance and future slide.
Working capital loans are a good way to cover unexpected expenses without exhausting your cash reserves. A short-term loan, earmarked for dealing with the emergency at hand and keeping your business running, is often the ideal solution to an unexpected setback.
Working Capital Financing Solutions
Working capital loans help small businesses continue to grow and thrive when revenue streams are sluggish and cash reserves are strained. The right loan, from the right lender, can help fund the expansion of a promising start-up or underwrite the retooling of an established local manufacturing firm. It can pay for the hiring and training of valuable new employees or settle outstanding debts with long-term vendors and suppliers. The uses of a working capital loan are many and varied, and are only limited by our ambitions as business owners.