The Best Working Capital Loans for Small Businesses

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    Key Takeaways

    • Working capital loans for small businesses are a great way to remedy cash flow gaps and cover day-to-day expenses. However, unlike other conventional loans, they usually have shorter repayment periods and lower loan amounts. As such, they’re best used to address short-term business needs like reordering inventory, covering temporary cash flow gaps, hiring staff, and product expansions, to name a few.
    • Online term loans, business lines of credit, invoice financing, SBA 7(a) loans, and merchant cash advance are examples of working capital loans small businesses can apply for.
    • When looking for the best working capital loan for your small business, start by evaluating your business’ qualifications. From there, determine the loan product that will fit your current financial situation and find the lender that offers the best terms based on your situation.

    Operating a business requires ongoing expenses. A company may be able to rely on their savings for the first few months of operation, but as time goes on, it will likely need a cash flow boost that requires outside financing.

    In such instances, working capital loans are a viable solution. In this article, we’ll discuss what working capital loans are, and outline the different options to consider when addressing your business’ capital needs.

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    What is a Working Capital Loan?

    Working capital loans are a type of business financing with shorter repayment lengths and smaller loan amounts designed to sustain a company’s operational expenses and other business initiatives. With one, the borrowing business is provided with enough funding to stay operational throughout the year.

    Working capital loans come with several benefits. For one, they’re easy to qualify for. Many online lenders offer working capital loans to startups lacking sufficient credit history. Additionally, they give businesses a way to cover short-term cash flow gaps, preventing major cash flow issues from arising.

    But before we go deeper into working capital loans, it is crucial to understand what working capital is and why you always need to have enough.

    Simply put, working capital is the difference between your company’s current assets and liabilities. You can calculate it using this formula:

    Current Assets – Current Liabilities = Working Capital

    Your working capital should ideally be enough to cover your day-to-day expenses and any other investments you plan to make. If it is not enough to meet these costs, there’s a high chance your business won’t be able to operate efficiently, which could cause problems with your sales and cash flow. This is where a working capital loan may come in handy.

    Working Capital Loan Uses

    Sufficient capital is vital to the survival of any business. Working capital loans give businesses the flexibility they need to cover almost any business need.

    Aside from covering day-to-day expenses and unforeseen business costs, businesses can also use working capital loans for:

    • Relocating or expanding to another location
    • Reordering inventory
    • Hiring staff
    • Refinancing or consolidating existing debt
    • Funding a new marketing campaign

    Since its repayment structure is less flexible and lower funding amounts are granted to businesses, it is worth noting that this type of financing is not suited for investing in long-term goals.

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    What are the Different Types of Working Capital Loans?

    Seasonal businesses, or companies that have cyclical sales, are usually more prone to working capital shortages. When looking for a capital boost, it’s important to be aware of the different types of working capital loans you can apply for. We’ve gone ahead and laid the best options out here, detailing how each one works:

    1.    Online Short-Term Loans

    Short-term loans are tailored to help small businesses get quick access to cash to address short-term capital needs. Once approved, the company will receive a lump sum of cash up front, which it can repay in increments (usually daily or weekly depending on the lender).

    Unlike other term loans, this financing comes with a lower loan amount, shorter repayment period (less than one year), and higher interest rates. Businesses usually use short-term loans to manage cash flow, cover emergency expenses, or to fund any unexpected business opportunities.

    While some banks may offer short-term loans to SMEs, this type of financing is usually more accessible through online lenders. With such lenders, the application process can be quicker, more streamlined and more flexible. The funding is also faster compared to other types of loan products.

    2.    Working Capital Lines of Credit

    With working capital lines of credit, the lender grants businesses with a credit line that has a pre-established credit limit. You, the borrower, can then withdraw from that credit line as needed, as long as you don’t exceed the limit.

    Many seek business lines of credit for its flexibility. It can be used to address several types of business initiatives, like buying office supplies, making equipment purchases, bridging short-term cash flow gaps, product expansion, renovations, among other things. For many businesses, a line of credit becomes especially handy when facing unforeseen or emergency expenses.

    With a line of credit, you’re only required to repay the amount you’ve drawn from the credit line, plus the interest. Every time you withdraw money from your account, your credit limit goes down. It goes back up every time you make repayments. Since it’s a revolving credit, you can then re-access the same set of funds if the need arises.

    3.    Invoice Financing

    Invoice financing, or accounts receivable financing, is a form of business borrowing where the borrowing business uses their customer’s outstanding invoices to get advance capital. Eligible businesses can get up to 85% of the total value of their customer’s invoices financed.

    Like the others, invoice financing also offers flexibility. With it, the business can:

    • Bridge cash flow gaps
    • Reorder more inventory
    • Order office or store supplies
    • Cover day-to-day expenses
    • Invest in business opportunities such as product expansion
    • Purchase equipment

    One of the biggest benefits of invoice financing is that it’s typically easy to qualify for. Since the repayment primarily relies on your customer’s ability to settle their invoices, your credit background won’t be the main consideration for eligibility. Instead, the invoice financing company will look at your customer’s credit background to determine whether the invoices qualify for funding or not.

    Although it’s not impossible to get 100% of the total value of your invoices financed, you’ll have to show the lenders that you’re working with highly credible customers and that you have healthy business financials.

    4.    SBA 7(a) Loans

    One of the best loans available for businesses out there is SBA loans. The SBA 7(a) loan, in particular, is the most coveted SBA loan. Aside from the excellent terms it offers (i.e., low-interest rate, longer repayment length, and higher loan amounts), it also offers the most flexibility.

    With the SBA 7(a) loan, you can qualify for up to $5 million in funding with a repayment period of up to 25 years, depending on the project you’ll be funding. With that amount of capital, you can address any business need, including:

    • Business acquisition
    • Commercial property construction
    • Commercial real estate purchase
    • Equipment purchase
    • Bridging seasonal cash flow gaps
    • Creating a safety net for emergencies
    • Covering day-to-day operational costs
    • Refinancing debt

    However, SBA loans are notoriously known for their stringent and lengthy application process. If you’re moving forward with the application, know that you’ll need stellar credit to qualify. You’ll also have to submit a long list of documents, pledge collateral, and wait a few weeks to months for approval. So, if you’re looking for extra capital to address time-sensitive business matters, this might not be the best financing.

    5.    Merchant Cash Advance

    Merchant cash advances (MCA) allow businesses to receive an advance on capital which they then repay using their future credit or debit card transactions. Typically, the MCA company will take an agreed-upon percentage of their daily or weekly credit or debit card transactions until the loan is paid in full.

    That said, the amount you have to make towards repayments will depend on your daily or weekly sales volume; if you have lesser sales that day, the amount that goes towards the repayment will also be lower. Conversely, if your sales are high, the percentage that goes towards MCA repayments will also be higher. That also means you’ll be able to pay off the loan faster.

    Merchant cash advances are technically not considered a loan as you’ll be selling a portion of your future debit and credit card transactions at a discount. While MCAs are easy to qualify for, this type of financing tends to be expensive. For that reason, financial experts would advise you to consider other funding options first before turning to merchant cash advance.

    Choosing the Right Working Capital Loan for Your Business

    Now that you know more about the different working capital loan options available to you, how should you go about choosing the one that best meets your business’ needs? Here are a few tips to help you make an informed choice:

    1.    Evaluate your business’ qualifications.

    Good credit and financial standing are essential in qualifying for a business loan with excellent terms. SBA loans, specifically, may require the borrowers to have a credit score of at least 650 or better, a six-figure annual revenue, and a business history of at least two years. If you meet all of the requirements, you’ll have a higher chance of qualifying.

    On the other hand, if your credit and financial standing are less than stellar, you might be better off with a different financing solution. Online lenders may be more willing to work with you. However, you can expect the interest rates and repayment terms to be less flexible than SBA or traditional bank loans.

    2.    Determine the type of loan that best fits your situation

    Most working capital loans offer some flexibility when it comes to how you can spend the proceeds. However, some of them may require your credit to be in good standing or oblige you to pledge an asset as collateral. Lack thereof may result in the rejection of your application, or if they do approve you of the loan, you’ll be offered less favorable financing terms.

    Take a look at your business’ current situation and assess whether you can pledge collateral or afford the loan repayments (if you end up with high-interest financing). The last thing you want is to end up with a loan you can’t afford to pay back.

    3.    Look for the right lender

    Many lenders may refuse lending to high-risk businesses. If this is what’s stopping you from getting the extra capital you need, you’ll be glad to know that there are lenders that specialize in a specific industry and might be able to provide you with the loan you can’t get anywhere else. In some cases, they may even offer excellent terms despite your risky nature or poor credit standing.

    When looking for a lender, be sure to ask them about their experience in your industry. Do your research and see if you have friends that can vouch for their reputation. Getting business financing is a major decision for the company, so you want to work with a reputable and trustworthy lender to help you with your capital needs.

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    Working Capital Loans for Small businesses FAQs

    1. Can I still qualify for a working capital loan with a bad credit score?


    But not from banks. Banks reserve their loan products for only the most creditworthy customers. Alternative lenders, on the other hand, might be willing to take on the risk of lending to small businesses with a less than stellar credit standing. They do, however, charge higher interest rates than banks.

    2. Where can I get a working capital loan?

    Both banks and alternative lenders offer working capital loans.

    If you’re looking for a much faster way to access extra capital, working with alternative lenders such as online lenders would be the most viable way to go. As mentioned, online lenders have a more streamlined application process, and they’re more likely to work with startups that lack the credit and financial history that banks require. Businesses that get approved for online working capital financing can get funded within 24 hours after loan approval.

    3. How to calculate overhead costs?

    You can use this formula to calculate your overhead costs:

    Current Assets – Current Liabilities = Working Capital

    A lower overhead rate is generally seen as a positive sign, indicating that a business is efficient and more profitable.

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    Bottom Line

    Working capital loans for small businesses can be a lifeline to those who are struggling to meet their day-to-day expenses. However, it is vital to research the different working capital loans and their associated costs before applying for one. Compare lenders and choose the one that best suits your business’ current credit and financial standing. The last thing you want is to end up with a loan you can’t afford.

    Ready to apply for a Working Capital Loan?