Working Capital Loans

What is working capital?

Working capital is an important metric used to measure a business’s short-term financial health. Working capital is the difference between a business’s current assets and current liabilities; this balance can be either positive or negative.

Put simply; working capital is how much cash your business has left after you account for any money coming in or going out of your business over the next 12 months.

To work out your business's working capital, you need to add together all of your current assets and take away the total number of current liabilities.

Current assets are the assets a business expects to use, consume, replace or sell throughout the year; this typically includes:

• Business cash, held in either a current or savings account
• Inventory
• Accounts receivable
• Prepaid expenses

Current liabilities are a business’s short-term financial obligations, due within 12 months. Current liabilities tend to include:

• Short-term debt, such as business credit cards or bank loans
• Accounts payable
• Rent, utilities and other normal operating expenses
• Accrued expenses & taxes
• Deferred revenue

What is a working capital loan?

Working capital loans are a form of short-term borrowing that can be used as a way to finance a business’s everyday operating expenses. These loans are typically paid back within 12 months or less.

Working capital loans can be a useful tool for businesses whose income fluctuates throughout the year, such as a company that sells seasonal goods or services, where income goes up and down from month to month, but outgoings remain constant.

How do working capital loans work?

Working capital loans can be either secured or unsecured and are used to finance a business's everyday expenses, such as wages, rent and materials.

Unsecured working capital loans are often only an option for businesses with a good credit score, although some providers may require a personal guarantee.

A personal guarantee is an agreement between the business owner and the lender that states they are responsible for paying back the loan if the business is unable to.

Secured working capital loans are an alternative option if your business doesn’t have a good credit rating, or you don’t want to personally guarantee the loan. These loans are secured against collateral and are therefore seen as less risky for the lender.

What can I use a working capital loan for?

There’s no hard and fast rule around what you can use a working capital loan for, but they’re typically used to help manage a business’s cash flow and everyday spending. However, they’re a short-term solution used to bridge gaps in a business’s income and outgoings and shouldn’t be used for long-term investments.

Reasons businesses use working capital loans include;

• Manage business cash flow - Managing cash flow is an integral part of all businesses. Working capital loans can help firms who are struggling with cash flow get back on their feet and cover the day-to-day expenses, like paying staff salaries, rent or utilities.
• Cover seasonal expenses - Businesses experience fluctuations in income during the different seasons; for example, many retail businesses will see an uplift in purchases during the Christmas season. This type of retailer may wish to use a working capital loan to cover the cost of hiring seasonal employees or purchase extra stock ready for the Christmas period.
• Bridge delayed payments - Working capital loans can be used when a customer is late paying a bill or invoice. Overdue invoices can make managing payments difficult; a working capital loan can help bridge the gap until delayed payments are made.
• Unexpected expenses - A working capital loan can help businesses to cover any unforeseen bills or expenses.
• Business growth - Capital loans can aid businesses during periods of rapid growth, whether it’s to cover the costs of hiring and training new employees or to invest in marketing campaigns.

How much does a working capital loan cost?

The cost of a business working capital loan will depend on a number of factors.

Firstly, the interest rate you pay will be determined by the financial health and credit history of your business, what type of loan you apply for, and whether or not you’ve personally guaranteed the loan. Secured loans generally come with lower interest rates than unsecured loans.

Many lenders will also charge an upfront fee for arranging the loan, so it’s a good idea to compare your options and weigh up the total cost of the loan before choosing a lender.

What are the pros and cons of working capital loans?

As with all business loans, working capital loans come with benefits for the business, but they can also have downsides. Below are some of the pros and cons of working capital loans;

Pros

• Stay on top of cash flow - Managing cash flow is an integral part of every business; working capital loans can help firms avoid any cash flow problems that may arise.
• Fast - As a form of short-term business finance, working capital loans can be arranged and repaid quickly, meaning businesses can get quick access to funds in emergencies but aren’t tied up repaying the loan for long periods either.
• Don’t always need collateral - Many working capital loans won’t require collateral. However,if your business has bad credit or you’re looking for lower interest rates, then you can provide collateral to secure the loan.
• Few restrictions on how you spend the loan - Whilst working capital loans are short-term and shouldn’t be used for long-term investments; there are very few restrictions on how you can use the loan.

Cons

• Unsecured loans have high-interest rates - If you don’t want to provide collateral, an unsecured working capital loan may charge a higher interest rate than if you were to apply for a secured working capital loan.
• You may need to personally guarantee the loan - Whilst this isn’t an issue if the business can pay back the loan, you will be personally liable for repaying the loan if the business can’t.
• Loss of business assets - If your business takes out a secured working capital loan and is unable to repay it, any collateral put up to secure the loan could be taken by the lender to repay the balance.
• Have to repay the loan quickly - Working capital loans are a type of short-term finance, and whilst being able to repay them quickly may be a good thing for some, other businesses may struggle to repay the loan within a short period of time.

Are there any alternatives to working capital loans?

Working capital loans can be a useful tool for many businesses, but they’re not always the right choice for some companies; here are some alternatives;

Invoice financing

Invoice financing is a form of business funding that uses a company's unpaid invoices as collateral.

This form of funding can be a good option for businesses that have lots of capital tied up in unpaid invoices.

Business lines of credit

Lines of credit are a form of revolving business financing that you can use when needed. The lender will give you access to a fixed amount of money, but you choose how much and when you need to use it. You’ll also only need to pay interest on the amount you borrow and not necessarily on the full limit.

Business Credit Cards

Business credit cards allow a company and their employees to borrow up to a certain limit and can be a handy way for firms to manage their cash flow. Most business credit cards will come with an interest-free period, meaning that if the balance is repaid within that time, you won’t be charged any interest.

Merchant Cash Advance

This is a form of funding available to businesses that take card payments. With a merchant cash advance, a lender, working with card providers, will loan you an amount of money which will then be repaid from the debit and credit card payments you receive each month.