Most small business owners need extra working capital at some point, regardless of their financial health. A host of unforeseen circumstances can cause revenue to dry up or compromise the majority of operational funding. Common examples include bad weather, changes in demand, or even a fire in the business next door. The certainty of these events resulted in the popularization of Working Capital Loans. While the typical financial institution and other business capital products are geared toward long-term investments or massive expenses, a working capital loan is designed to help businesses recover from temporary cash flow issues and take advantage of new opportunities.
If you don’t need a lot of money but need more than a little, working capital loans could be the exact solution you’re looking for.
Before diving into an explanation of working capital loans, it’s important to understand working capital basics.
Working capital refers to the money needed to cover everyday operating expenses in your business. Typical expenses covered by working capital include payroll and rent. These are the day-to-day costs of keeping your business running.
A working capital loan gives businesses the cash to cover these ongoing, everyday operational costs. A working capital loan can come in various forms, including a short-term working capital loan, merchant cash advance on credit card sales, invoice factoring agreement (on unpaid invoices due), SBA loans, or a business line of credit.
Working capital loans may also be known as business capital loans, operating capital, or cash flow loans.
Working capital comes from the cash flowing into your business due to your service or product sales in a perfect world. However, not all companies enjoy a smooth cash flow all the time. Your business could just be starting out and slowly increasing your customer base. Or maybe you operate a seasonal business. In this case, you might have less cash on hand during your off-season. A lack of working capital makes it tough to keep up with bills you must pay each month – bills due whether your business is booming or not.
When your business lacks working capital, you need to tap into a different cash injection source. That is where a working capital loan product can come into play.
So how does a working capital loan work? Though working capital business loans can come in many forms and from online lenders or a traditional financial institution like the small business administration in a few limited cases, each version has a few things in common. Unlike a more traditional bank loan, small business owners can access even the best working capital loans with a subpar personal and business credit score and less than one year in operation. You don’t need collateral or even a personal guarantee. Due to these loose requirements and the shorter terms, interest rates tend to run higher.
Since working capital financing is more accessible through online lenders than traditional financial institutions, companies don’t have to specify how they plan to use the money. Thus, they would recommend the repayment terms that make the most sense for your cash flow and the problem at hand.
Some alternative lenders like Kabbage Funding offer multiple types of funding products. For example, a Business Line of Credit might be best for a highly seasonal business looking to cover day-to-day expenses during the slow season. On the other hand, Merchant Cash Advance providers might think that the product might be best for a company looking to bridge a much shorter gap in cash flow. Some lenders may recommend business credit cards. For standard short-term loans, terms can be as little as just four or five months. Other types of working capital loans can have terms as long as several years.
Also, your borrowing amount isn’t just the sum of your monthly business expenses. It must additionally account for your current/short-term liabilities or what your business owes in the near future (loans, accounts payable, taxes, etc.). To run your business, the borrowing amount must exceed your short-term liabilities.
According to the 2022 Small Business Credit Survey, 54% of respondents said they had financial challenges related to difficulties paying operating expenses.
The Fed’s 2019 Small Business Credit Survey estimates that the small business financing market is about $1.4 trillion in size.
In 2019, the Small Business Credit Survey also found that medium- and high-credit-risk applicants seeking loans or working capital line of credit financing were almost as likely to apply through online lenders as they were to complete an application with a traditional large bank (54% and 50%, respectively). However, only 41% were likely to apply for credit through a small bank.
Also, in 2023, the SBA reported approving 53,700 SBA 7(a) loans totaling $27.5 billion. The SBA does offer working capital loan programs, even some tied to any real estate owned.
Working capital loans are incredibly accessible and can be approved in as little as 24 hours. You don’t need an excellent credit score, collateral, or more than six months in operation.
This is because working capital financing is designed primarily for businesses dealing with unforeseen circumstances. Products with a long term, higher borrowing limits, and lower rates tend to have lengthy application processes. Business owners must also figure out exactly how much funding they need. On the other hand, most small business owners are just looking for enough money to cover everyday business expenses and other short-term business liabilities with working capital loans. When a business owner can easily calculate their desired funding amount, the application process goes much quicker.
Another advantage is the availability of multiple repayment structures. With the help of your small business lender, you can choose the repayment structure that most effectively solves your dilemma. And though working capital loans are frequently used to fill cash shortages and pay short-term debts, small businesses can also use them for growth-related investments like ordering inventory or taking on a larger, costly project.
Other types of small business loans aren’t as versatile. Business owners can only use them for a few purposes. For example, you wouldn’t take out a Term Loan or SBA Loan to cover operational expenses.
Loose requirements place a heightened degree of risk on alternative lenders. In other words, business owners with poor credit, cash flow problems, and less than one year in operation are less likely to repay the loan on time. Thus, online lenders offset this risk by assigning higher interest rates and shorter terms. A high interest rate could jeopardize your small business if your cash flow doesn’t recover. That’s why you should only explore working capital loans if dealing with a temporary issue.
Working capital loans also generally come with lower borrowing amounts than Business Term Loans and SBA Loans. For this reason, you can’t use a working capital loan for expensive initiatives like developing a new product, renovating your physical space, adding a new division, etc. Remember, working capital loans work best for short-term needs instead of long-term investments that may take years to produce results.
| LOAN TYPES | MAX AMOUNTS | RATES | SPEED |
|---|---|---|---|
| Merchant Cash Advances | $7.5k – $1m | Starting at 1-6% p/mo | 1-2 business days |
| SBA Loan | $50k-$10m | Starting at Prime + 2.75% | 8-12 weeks |
| Business Term Loan | $10k to $5m | Starting at 1-4% p/mo | 1-3 business days |
| Business Line of Credit | $1k to $250k | Starting at 1% p/mo | 1-3 business days |
| Receivables/Invoice Financing | $10k-$10m | Starting at 1% p/mo | 1-2 weeks |
| Equipment Financing | Up to $5m per piece | Starting at 3.5% (SBA) | 3-10+ business days |
| Revenue Based Business Loans | $10K – $5m | Starting at 1-6% p/mo | 1-2 business days |
The application process may be slightly longer or shorter for different types of loans. However, all variations require very little paperwork, and you can get funded in just a few business days. Here’s how to get started:
We usually recommend the loan options that feature the most uncomplicated repayment terms for your cash flow. This depends on the length of your cash flow gap and how quickly you can pay off the loan.
This step depends on the type of loan options you’re applying for. Here are the documents and information you may need to get started for each option:
You can begin the application process by calling us or filling out our one-page online application. Either way, you’ll be asked to enter the information from the previous section along with your desired funding amount.
Once you apply, a representative will contact you to explain the repayment terms, rates, and terms of your available options. This way, you won’t have to worry about any surprises or hidden fees from lenders during repayment.
For most loan products, credit approval only takes a few days. Depending on the type of loan, funds should appear in your bank account in 1-3 business days for most funding options.
Your loan isn’t just a way to get financing for your business. It’s also an excellent opportunity to start building (or improving) your credit.
Regardless of the type of business loan your company gets, make all your required payments on time and in full. If you get a business credit line or another form of revolving credit like business credit cards, keep your balance below the credit limit.
Consistently making your business financing payments on time and in full will positively impact your credit. And that means preferred rates and terms when you next need business financing.
If your application gets declined, it might be due to poor personal credit or the conclusion that your company cannot afford to take on more debt at this time. In this case, we might recommend alternative tools for financing your business, like a business credit card or even a personal loan. Both financing options are much easier to qualify for than small business loans from traditional financial institutions.
You might also consider credit unions for working capital financing. Credit unions generally have excellent terms and are easier to qualify for if you are a member. That might be your best option if you can qualify through credit unions.
We might also recommend credit repair services, which focus on raising your personal credit score by identifying and eliminating the issues keeping it down. Fixing your credit, in general, will help you pay interest at lower rates for all types of financing.
This product makes sense for short-term needs or cash flow gaps that last a few months. In addition to covering expenses during a rough patch, common functions include ordering inventory, paying short-term debts, or taking on expensive projects that would otherwise compromise operational funding.
If you want to finance a long-term investment, consider a Business Term Loan or SBA Loan instead.
To calculate your business’s working capital, see the calculation below. The numbers that make up both parts of the equation should appear on your most recent balance sheet.
Current Assets = What your business owns (Cash, Inventory, Accounts Receivable, etc.)
Current Liabilities = What your business owes (Bills, Payroll, Loans, Accounts Payable, etc.)
Net Working Capital = Current Assets – Current Liabilities
Your current assets must exceed your current liabilities in meeting short-term business obligations. , if you intend to grow your business, you should increase the gap between what your company owns and owes.
The working capital formula will produce an amount in dollars. Sometimes, though, looking at this number won’t immediately tell you if you have healthy working capital. Due to individual factors like industry or company size, healthy working capital for one business could represent the bare minimum for other companies.
The answer to your working capital ratio, on the other hand, leaves no room for uncertainty. While the net working capital formula subtracts assets from liabilities, the working capital ratio formula divides them.
Current Assets / Current Liabilities = Working Capital Ratio
A ratio between 1.2 and 2.0 usually indicates a healthy operating capital level. However, a ratio higher than two might suggest insufficient spending or too much unused operating capital. If your ratio is less than one, you may face liquidity problems in the near future. Maybe you’ve neglected to invest enough profits back into the company or failed to spend enough money to generate growth.
You might use your working capital funding for any of the following things:
Of course, you can use your working capital loan for other reasons that will help your business.
Yes, a business owner can access all types of working capital loans with bad credit. However, it’s important to remember that credit score plays a different role in different products. For example, your borrowing amount for a merchant cash advance is based almost entirely on your monthly debit and credit card sales. Likewise, your credit score hardly impacts the accessibility of accounts receivable financing on unpaid invoices and most other short-term loans.
On the other hand, for a short-term working capital loan, your credit rating is indeed factored into your borrowing amount, along with your rates and terms.
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Please be aware that individuals have been fraudulently misrepresenting to business owners (and others) that United Capital Source, Inc. (“UCS”) can assist small businesses in receiving government grants and other forgivable business loans, when in fact those grants or loans do not exist or are not available. These individuals have ulterior motives and are engaging in the unauthorized use of the names, trademarks, domain names, and logos of UCS in an attempt to commit fraud upon unsuspecting small business owners.
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