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Finance & Accounting, Financial Glossary, Financial Management, Small Business Loans, Working Capital

Working Capital Loans – The Advantages and Disadvantages

Working Capital Loans

Working capital loans are a great way for businesses like yours to generate capital and to start becoming laser-focused on business growth. To get anywhere in the world of business, it is extremely important to have capital on hand to cover marketing costs, payroll, and any other financial expenses that occur within the daily operations of your business.

Working capital is the money available to operate the immediate and short-term needs of your company. Your capital is often in the form of cash at a bank or redeemable notes. And, many times a small business like yours might not have enough it. Although you may have been successful in the past in securing some form of business startup financing and establishing a sound customer base, on-going access to the working capital required to fund further growth can often become a stumbling block for many business owners at some point.

Many small business owners may turn to their own personal resources to meet their businesses financial needs. Although it seems like a good idea at first glance, a better idea would be to utilize a working capital loan to keep money in your businesses (and personal) pocket, as well as meeting your needs with cash to spare. As the name suggests, working capital loans are meant to finance everyday expenses (such as pay employee wages) related to the daily operation of a business. It is not meant to be used for things such as investing or buying long-term assets.

As a company grows, it starts to tie up a lot of cash in the day to day operations of the business that has nothing to do with its profits or losses. This type of cash consumption is called working capital. In accounting terms, working capital is equal to current assets minus current liabilities. In everyday terminology, working capital is what your customers owe you plus any inventory you have built up minus what you owe your suppliers and employees. Working capital also includes any cash you have in the bank.

So, what is a working capital loan? A working capital loan is a specialized loan type that is granted to businesses and designed to meet the everyday financial needs of running a business. Unlike traditional business loans that are designed for specific purposes with working capital loans for small business, your business is not required to submit the loan’s purpose to the lender during the application process, they will approve the loan regardless to what it is being used for within the business. Typically working capital loans are not used to purchase assets or for long-term financing, it is a short-term business financing option offered by lenders.

What Can Working Capital Loans Cover and Why Do You Need Working Capital?

The list of business items you should not use the loan for (purchasing assets, long-term funding) is much shorter than what you can use it for! The name really gives it away, although the situations are different, the end goal is the same, increasing working capital. There are a number of different options based on your business’s needs.

Maybe you know that you will have a number of slow months during the year, you can use the loan to meet your payroll or other recurring payment obligations during those months. Or, perhaps you need to stock up on inventory before the coming holiday season and you don’t have enough cash on hand. Along the same lines, your loan would allow you to be able to take advantage of discounts on purchases offered to you by vendors. Those once in a lifetime offers sometimes do only come around once, so it’s nice to have the cash you need if an opportunity comes knocking.

Small businesses use these short-term loans to cover unexpected losses as well. Perhaps you have increased expenses due to additional marketing efforts, new employees, or relocation of an office. Or the time has come for you to update, expand or renovate your current office space or product lines. Maybe the economy has led to you having an additional number of slow paying customers and you need to make up funds. And it’s possible that some recent operating losses could have reduced or depleted your cash reserves. To put it simply, for just about any business looking for some quick financing, a working capital loan is definitely a great choice to consider.

Advantages of Working Capital Loans

  • You are prepared to handle any financial difficulties that may arise. Even a business that has billions of dollars in fixed assets will quickly find itself in bankruptcy court if it can’t pay its monthly bills. Under the best of circumstances, poor working capital leads to financial pressure on a company, increased borrowing, and late payments to the creditor – all of which result in a lower credit rating. A lower credit rating means banks charge a higher interest rate for any money borrowed. Applying for and using a working capital loan when you need it most will keep you in business when shortages occur.
  • You can and will maintain ownership of your company. If you were to receive funding from an equity investor, you would likely have to give up a generous percentage of your company in return. In turn, you are giving up a portion of your decision-making ability as well. But, if you borrow funds from the bank or another financial institution, you are obligated to make the agreed-upon payments on time. But that is the end of your obligation to the lender. You can choose to run your business however you choose without outside interference.
  • There is no collateral required. In general, there are two types of loans, secured and unsecured. Working capital loans come in both flavors, although many are unsecured. Unsecured working capital loans are given only to those small businesses that have a very good credit history and/or have little or no risk of default. If you are lucky enough to qualify for an unsecured loan, you won’t need to put up your business, inventory, or anything else to secure the loan. Of course, paying the loan back is critical, because they will come after you.
  • They offer shorter terms for short-term problems. Working capital loans are designed to help with infusing money into your business for the short term. A hiccup here, a blip there, and a needed cash injection too. You won’t have to plan for years of monthly payments to pay back what you borrowed.
  • You can use the money however you see fit. Banks and lenders have few if any restrictions on how you use the money. They just want you to use the money to maintain your operations or to do things that will increase your opportunities for revenue. That works out well because as a smart business owner, that is exactly what you want to do with it too.
  • They are quick! Applying for a typical business or personal loan can take up a lot of your valuable time, and may not end in approval. What’s the point of going through excessive paperwork, a lengthy approval process, putting up collateral, personally guaranteeing the loan, making fixed monthly payments and having restrictions on how you use the money if your request is just going to get denied? A working capital loan is a great way to get money fast and without the hassles associated with a traditional bank loan. These loans allow borrowers to access money almost immediately, usually within a week after the application is accepted.

Disadvantages of Working Capital Loans

  • You need to consider repayment. Yes, you actually have to repay the loan. This is usually a given when you borrow money. As with any type of loan, your sole obligation to the lender is to make your payments. Unfortunately, even if your business fails, you will still have to make these payments. And if you are forced into bankruptcy, your lenders will have a claim to repayment before any equity investors.
  • Some collateral is required. Many working capital loans will require some degree of security for the lender. In today’s economy, a bank would like some assurance that you will pay them back. A secured loan is one in which collateral is received in exchange for funding. The guarantee may be something like a factory, home, inventory or even jewelry. These items can also be given as a guarantee even if there are existing mortgages on them. Although the amount of collateral for a loan of working capital may vary with banks, most typically look at information such as credit rating and other small business loan information to see your credit repayment history.
  • There are higher interest rates. Because unsecured working capital loans are more risky for lenders, they usually include higher interest rates than secured business loans. This will mean that your business will pay more over the life of the loan than it would have paid for a secured loan of the same amount. Higher interest rates also cause the individual loan payments to be higher and sometimes more difficult to afford. Finally, unsecured business loans are harder to qualify for. If your business has a poor or nonexistent credit history, the lender may not approve your application.
  • There are potential impacts on your credit rating. It might seem like a good idea to keep taking out loans when your small business needs money, but each loan will be noted on your credit rating. And the more you borrow, the higher the risk to the lender, and the higher interest rate you’ll pay. Also, slow payment and no payment will be direct hits to your credit rating, so be sure you will be able to pay back any money you borrow.
  • There are short terms. Yes, this is both a benefit and a disadvantage based on your business needs. A major disadvantage of getting funds from this type of loan is the fact that the funding is only intended for short-term solutions. These loans will not suffice for long-term business goals or comprehensive business projects that will need higher investments with longer repayment terms.
  • Banks will sometimes loan short-term money to small businesses to enable them to get off the ground and grow. Working capital loans are a great way for businesses like yours to generate capital and start focusing on business growth. To get anywhere in the world of business it is important to have capital on hand to cover marketing cost, payroll, and any other financial expenses that occur within your business. Rather than exhausting all of your finances to meet your financial needs use a working capital business loan to keep money in your businesses pocket as well as meeting your needs with cash to spare.

Are You Ready To See What Working Capital Loans Can Do for Your Business?

A working capital loan is one of the easiest ways to explore the maximum potential of your business. If you’re in a solid financial position, but just need a little extra help to make that necessary expansion or find that extra staff member that can give your business a start, why not consider what one of these loans could do for you? With easy repayment plans that don’t require you to give up a portion of your business as an investor would require, you can solidify your credit while you also build your reputation. If the time is right, apply for one today if you’re ready to take your business to the next level!

Working capital can also be found through Kabbage which offers business loans in under ten minutes. It’s free to sign up, and there’s never any obligation to take the money you’re advanced. With a Kabbage business loan, you can get that deal on inventory, buy a piece of equipment to make your business more efficient, or even hire the help you need for the busy season. When you need a small business loan or business line of credit, Kabbage is the smart solution.

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Kabbage Team

Kabbage is here not only to provide access to the small business funding you need, but to also help you grow your business through free marketing tips, webinars, tools and more. Is there something you'd like us to cover or want to get your small business featured on our blog? Send us a note at content@kabbage.com.