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Working capital loans are used to finance the daily operation of a business. They are not designed to buy long-term assets or to make investments. As such, the proceeds from a working capital loan can be the “bread and butter” of the business that keeps it functioning while the business experiences growth.
Although banks have traditionally offered the lowest rates for working capital loans, times have dictated that many business need alternative financing to maintain capital for everyday business expenditures.
The following information will provide an insight into the best uses and options for working capital loans:
The first option a business owner can turn to before trying alternative financing is a bank, because banks offer lower interest rates. The majority of banks are willing to offer low financing for a working capital long, as long as the borrower as an established business that has a strong work flow. Of course, other considerations, such as credit history will factor into the approval.
It is expected that the business owner has a plan in place for how the proceeds will be used before applying. Most commonly, working capital loans are used for the following purposes:
Working capital loans are designed for immediate needs, never for long-term investments like real estate or business acquisition.
The process that the lender uses to decide if a business qualifies for a working capital loan is by subtracting the business’s current liabilities from their current assets. The amount that is left over is what is considered the amount the business has to work with. It is this amount that is borrowed against if the lender approves the loan.
Lenders consider some of the following criteria when deciding to approve a working capital loan:
If the application for a working capital loan is approved, the borrower has to contract for specific terms of repayment, which vary by lender. Often, repayment is based upon a daily sales percentage, in addition to interest. As an example, a business with daily sales of $100, who agrees to pay 10 percent of daily sales plus $1 in interest will pay $11 each day. Most working capital loans also come with fees which must also be paid in addition to monthly payment and interest.
Sometimes a business needs a loan to cover gaps in its cash flow caused by customers who pay their invoices late. A type of working capital loan to assist with this situation is called invoice financing. The way it works is that the lender finances the amount of all of the outstanding invoices, which they collect upon once the customer pays. The downside to this financing is that the interest rate is quite high, although it has been a lifesaver for many businesses.
Working capital loans can also be offered based upon the value of confirmed sales orders of the business. Companies use this type of loan very often to fulfill confirmed sales contracts or orders. An accounts receivable working capital loan is not available for new businesses without a proven track record. Lenders offer account receivable loans to proven reputable companies with good credit and a reputation for fulfilling business obligations.
Working capital loans are a financial product with advantages and disadvantages which should be considered prior to apply for a loan. Advantages of working capital loans include:
Among the disadvantages of working capital loans are:
In summary, a working capital loan, like other types of business credit, is a necessary product for business owners. They are very useful in preventing interruption of daily business operations. Working capital loans come in a wide variety of shapes and sizes, this flexibility allows business owners many financial choices to find the one that makes the most business sense to their company’s unique circumstances.
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