In order to survive, your business needs a constant supply of working capital. When it fails, you can be sure that your business will cease to operate normally. It could mean that materials cannot be ordered, employees are not paid and invoices not taken care of.
A fresh supply of working capital through a short term loan for your business (a.k.a. a working capital loan) can re-invigorate your business and get it back on track.
What is Working Capital?
A short-term business loan is designed to equip your business with more working capital. The goal is to enable your business to continue to operate and keep the lights on during a rough patch.
Working capital is made up of current assets you have on hand, with current assets defined as those which can be converted to cash within 12 months. Subtract your liabilities from your current assets to measure working capital.
An Example of Working Capital
Let’s say you’re the proud owner of a custom handbag business. After subtracting $4,000 worth of liabilities from $12,000 in assets, the shop owner is left with $8,000 in working capital.
Under normal circumstances, this should be enough to fulfill a normal workload of 10 custom bags a month, right?
Why a Working Capital Loan Might Be Necessary
Continuing with the example above, say you suddenly receive an order for 50 bags to be delivered within a month for a new fashion store. You’ve only got $8,000 on hand to order materials, hire new employees, and/or install new equipment.
In a situation like this, a working capital loan can help the business capitalize on the unexpected opportunity. It may also cover any overtime if that is necessary. Once the order is fulfilled, you’d make a considerable profit– even after paying back the loan and fees.
Things You Need to Know About Working Capital Loans
The details surrounding working capital loans will vary by lender. But there are some general characteristics that you ought to be familiar with before applying.
- Most working capital loans are small. While most working capital loans are rather small, some can be worth as much as $250,000. Some lenders will start out at $5,000 for this type of loan.
- Speedy approval is expected. In order to meet the immediate operational costs of businesses, the approval process has been streamlined.
- They must be repaid quickly. As a rule of thumb, a working capital loan should be repaid somewhere under 2 years.
Some Disadvantages Associated with Working Capital Loans
Despite the attractive features of short-term working capital loans, there are a few drawbacks to be aware of.
- They will cost you more than other loans. This is due to their faster deliverance and shorter repayment period. Most business loans will have a repayment plan of five years or more, but a working capital loan must be repaid within 24 months.
- Using short-term loans could be viewed as poor financial management. Others may perceive that the need for a working capital loan is an indication of mismanaging business funds. This type of loan certainly does not prove mismanagement, but if you are attempting to attract investors, you may want to refrain from getting a working capital loan.
How To Apply for a Working Capital Loan
Applying for a working capital loan for your business is not nearly as complicated as trying to get a traditional term loan.
The process is quite simple: Fill out an application, let lenders check your credit score, and present several of your business’s bank statements.
Some Things You Need to Know About Credit Scores
There are two kinds of credit scores a lender might consider:
1. Credit Scores for Business: This is similar to a personal credit score and it basically indicates the same thing– how well the business handles its finances. Most lenders will use it to determine the likelihood of getting their money back if they were to offer you a loan.
Each credit reporting agency calculates these scores a little differently, but they are similar. As far as working capital loans go, most lenders won’t even look at your business credit score.
2. Credit Scores for Individuals: When it comes to providers of short-term loans, most of them will only look at your personal credit score. They do this because:
- People who are responsible with personal finances are also likely to handle business finances responsibly.
- Small businesses may also need a loan, but they may not have an official business credit score.
- The owner of a small business is most likely the one who will be paying for the loan, so the owner’s credit score will reveal the likelihood of repayment.
Conclusion: A Working Capital Loan May Help to Boost Your Business
Working capital loans can be leveraged strategically to produce large dividends. If you think a working capital loan can benefit your business, it’s time to request offers for working capital loans from online lenders.