Working Capital Loans: How to Find and Manage

By Daniel Lewis
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Working capital is the lifeblood of any given enterprise. It refers to the capital necessary for the day to day running of the company and is a primary measure of its operational efficiency and liquidity.

This is why all businesses invariably need to apply for a working capital loan at some stage of their life-cycle.

Best Working Capital Loan Providers

So, how to find and manage working capital in order to stay liquid and operational? Whether you are a new technology startup or a 5-year-old restaurant owner, you need to have the right level of working capital available. If you don’t, there are a number of online lenders that offer competitive terms and conditions. The best of these include:

kabbageKabbage offers a business line of credit, which can assist with working capital expenditure. There is a business credit card connected to this line of credit for ease of purchase. The line of credit extends up to $250,000.

ondeckOndeck provides term loans and business lines of credit to US businesses that meet its eligibility requirements. The term loans range up to $500,000 and the lines of credit up to $100,000.

lending clubLending Club is the world’s largest peer to peer lending marketplace connecting loan lenders with applicants. They offer a range of loans, including the working capital loan up to $500,000.

LoanBuilderLoanbuilder is a service offered by PayPal that provides short-term loans with very low rates. Loans up to $500,000 are available, and applicants must be in business for 9 months.

All of these lenders can provide the essential working capital necessary to keep companies up and running. The terms and conditions may vary, but the credit rating requirements are typically low – 560 for Kabbage, 550 for Loanbuilder, 600 for OnDeck, and Lending Club, with no minimum credit requirements for Fundbox.

Usually, companies need to be in business for at least 12 months to qualify, but with Fundbox it is as short as 3 months for both invoice financing and lines of credit. With Loanbuilder, businesses must be at least 9 months old. Most businesses are required to have between $50,000 –  $100,000 in annual revenue to qualify for these loans.

A lack of working capital is a big problem. What happens is that you won’t be able to repay your creditors on time. This will include any outstanding loans that you have.

As a result, you will start to incur more debt due to the interest accrued for late repayments. It could also annoy your distributors if you keep continually missing payments or paying them back late. This is unprofessional and sends out the wrong message to the people that you work with.

Detailed Working Capital Comparison

It can be a little tricky figuring out all of the different terms, interest rates, and repayment penalties when it comes to working capital loans. Which is why we have created a table below to help you out. Be careful when evaluating the interest rates and make sure you understand them. Different lenders can use different metrics with various criteria. Know what you will be paying each month and what you will be paying expressed as a total percentage over the life of the loan.  

The term ’working capital loan’ is used quite flexibly among lenders, and term loans and lines of credit are frequently used as working capital loans. The difference is that a term loan often denotes a loan for a specific purpose while a working capital loan is used for on-going operational expenses.

Lender Eligibility Total Amount Term Length Average Cost
Kabbage 12 Months In Business.

$52,000 Minimum Revenue

$2k – $250k 6, 12, Or 18 Months 1.5% – 10% Per Month
Ondeck 36 Months In Business, $100,000 Annual Revenue, 600 Minimum Credit Score $5,000 – $500,000 3 – 36 Months Term-loan Weighted Average Is 49.06% Apr.  LOC Weighted Average Is 35.2% Apr.
Lending Club 12 Months In Business, $50,000 In Annual Sales, ‘fair’ Or Better Credit Rating. $5,000 – $500,000 1 – 5 Years 9.77 – 35.98%
Loanbuilder 9 Months In Business. $42,000 In Annual Revenue. $5,000 – $500,000 13 – 52 Weeks 2.9% – 18.72% Fixed Fee
Smartbiz 2 Years In Business, 650 Minimum Credit Score, No Recent Defaults, Liens, Or Bankruptcies. $30,000 – $5 Million 10 – 25 Years 5 – 10% Apr

A Deeper Look Into Working Capital

A working capital loan is the most common kind of loan. After all, it is capital that keeps a business running, and working capital is the most important kind in order to keep it operational.

It is a general type of loan that is used to pay utilities, wages, materials, transport, third party services, etc. For the purposes of accountancy and business evaluation, the working capital of a business is calculated by subtracting the current assets from current liabilities.

Examples of business assets include inventory, cash, and money owed, often known as accounts receivable. All of these are described as current assets.  Next, the current liabilities are tallied. These current liabilities will include short term loans, accounts payable, and expenses. In short, liabilities are all the money that you need to pay out on a short term basis, whether to suppliers, banks, or other third-parties.

The current assets are subtracted from the current liabilities to give a clear indication of how much working capital a company has. Needless to say, the more working capital that a company has, the better, even if this is not the full picture.

Working Capital Loan Types

Most loans applied for are actually working capital loans. It is the most common kind of loan needed for the aim of maintaining and growing a business enterprise. Many popular kinds of loans could also be termed working capital loans. Examples include:

  • The SBA(7)(a) loan – This loan is guaranteed by the Small Business Association up to 85% and is the most common option for US business owners. The repayment term is long and the interest rates are low with the SBA(7)(a). Check out all of the SBA loan programs
  • Invoice financing/Invoice factoring Invoice loans can serve as a kind of working capital loan. It allows businesses to collect money for their outstanding invoices immediately, without delay. This frees up short term cash, though it reduces the total amount of current assets over the long run, as you won’t get the full value for the invoices.
  • The business line of credit – The line of credit is given to companies who draw upon it as needed in order to pay down current liabilities. It is perfect for businesses with frequent and large daily expenses and liquid cash flow.
  • The short term loan – The common short term loan is really just a working capital loan, designed to cover short term expenses such as payroll and utilities.

Many banks and online loan providers will offer a straight ‘working capital’ loan. This will allow you a greater degree of flexibility in terms of what you spend the funds on, as opposed to more specific loan options. Working capital loans are not used to buy long-term assets. So equipment financing and real estate loans would not constitute a working capital loan.

Merchant Cash Advance Working Capital Loan

The Merchant Cash Advance (‘MCA’) is a lesser-known type of working capital loan. Some would say it is not really a working capital loan at all. The way that the MCA works is that you will be given a lump sum in return for a future percentage of credit card sales. You are given an ‘advance’ in anticipation of what you will earn at a future date. The lender will judge what you are capable of earning in the future by looking at:

  1. Your previous sales
  2. Your credit history.

Because the MCA does not have a term length and is not collateralized, some contend that it is not a working capital loan. It is more closely related to invoice factoring, where an advance is given against an invoice.

The MCA is a little riskier for the lender. With invoice factoring, the factoring company is buying a portion of a company’s future receivables based on existing invoices. With the MCA, no invoice exists and the provider is using a ‘best guess’ on future income. As such, the MCA interest rate tends to be steeper.

The MCA is perfect for businesses that receive most of their sales from credit card purchases, as opposed to cash and other methods. The MCA provider will give you a lump sum based on prior purchases, and you can use these funds in any way that you wish, without any stipulations.

This is because the MCA is not technically a loan but an advance. MCA providers are careful not to be referred to as ‘lenders’, which allows them more flexibility when dealing with small businesses. 

Do You Have Enough Working Capital?

Working capital is expressed as a ratio. This makes it a lot easier to understand how much you have available. A ratio of 1.0 means you have exactly $0 in working capital. You might have $500,000 in current assets and $500,000 in liabilities. You are cash neutral, which is not ideal, but it could be worse.

If you have $600,000 in current assets and $200,000 in current liabilities, this means that you have a working capital ratio of 3.0. You have $400,000 in working capital. If you have $600,000 in current liabilities and $200,000 in current assets, then you have a working capital ratio of -3.0. You are in debt of $400,000.

Few lending institutions would be willing to take on this risk, as you are unable to manage your existing debt issue. It is more likely that you would go into default if you managed to acquire additional capital with a ratio of -3.0.

The Ideal Amount of Working Capital

A working capital between 1.2 and 2.0 is generally considered optimal. Higher than this and you need to invest more in your company, though it is easy to assume that higher is better.  Still, a working capital ratio that is too high is far better than a negative working capital ratio. There is nothing wrong with excess reserves.

It is important to remember that the working capital ratio can be a little misleading. For example, you might have a large inventory list that is on the books as a large asset. But in practice, this inventory might be hard to move quickly and is not really reflective of true working capital. This is just one example.

Sometimes, this ratio can be low and the business will still be healthy, such as a company with a flexible business line of credit. With the line of credit, there is no need for them to have large cash reserves, and they have the capability of paying back debts even with a low working capital ratio, due to this line. For this reason, the working capital ratio of a company has to be assessed with care.

The working capital ratio is a rough but important gauge when determining the value of a company. For larger loans, the amount of available working capital will play a more prominent role in determining whether or not you pass the application process. It shows you can be responsible for managing your cashflow, something which lending institutions need to look out for.

5 Typical Uses For Working Capital Loans

A working capital loan is typically used for everyday operational expenses that are needed to keep the business running. The working capital is arguably one of the most ‘flexible’ loan options available, as you can use it for a variety of different purchases, and the lending institutions are not all that interested in looking into it. In contrast.

Other loan types (such as equipment financing, CRE loans, or invoice factoring) have very specific purposes. The following are 5 typical uses for working capital loans. In practice, a working capital loan will be taken out for a number of purposes, not just one. So all 5 of the below might apply.

#1 – To Handle Cyclical Business

Many businesses are involved in industries that have variable income patterns. A prime example of this would be tourism. In some seasons, you might get a load of business, but in others, you might get very little. A working capital loan can help to smooth out this irregularity. You need to have enough funds to make it to the other end of the season, and a working capital loan can really help with this. Even if the business is not seasonal, you may simply run out of funds, for a myriad of different reasons. Employees need to be paid and so does the landlord, regardless of what the season is.

#2 – For Inventory and Supply

A common use for the working capital loan is to pay for inventory. The cost of inventory can be quite high, especially if you are selling inventory directly and need to pay for storage. A working capital loan can ensure that you always have the inventory at hand to keep the business operational and to make products available for customers. You can take advantage of huge discounts when you order in bulk with the help of a working capital loan, as opposed to ordering in an ad hoc fashion one at a time.

#3 – Expansion

If you are considering expanding the business, then a working capital loan can be used for this. You might need to launch an online marketing campaign, purchase extra materials for your physical business, or acquire new staff. Whatever your needs are, a working capital loan can cover you. Advertising, event sponsorship, direct marketing campaigns, signage, and other phenomena are common uses of these loan types.

You can also simply keep the cash at hand and when an opportunity for growth presents itself, you can jump on it without worrying about having the cash or not. For bigger expansion, such as the purchase of real estate or equipment, then a term loan or equipment financing loan is superior to the working capital loan.

#4 – General Operational Expenses

Working capital covers a huge number of processes. You could easily need to pay

  1. Rent.
  2. Insurance
  3. Payroll
  4. Inventory
  5. Utilities
  6. Short-Term Debt
  7. One-off payments
  8. Repairs
  9. Bonuses
  10. Marketing
  11. Accountancy
  12. HR

The list goes on and on and on. There are also hiccups that can disrupt your business (such as COVID-19), where it really pays to have the additional capital at hand. To keep your business operational, you need to have all elements working at their best. The working capital loan is designed specifically for this – to pay for the essentials that keep the business working in good stead.

#5 – For Financial Security

All business owners know the value of having extra cash at hand. And nothing is more stressful than barely surviving from month to month. The working capital loan is flexible enough to be used for a variety of different purposes so you are not tied down to one particular item. You can have the extra cash at hand just in case, and this peace of mind is invaluable.

Even if you don’t get a loan specifically for working capital, you have to ensure that you have at least 6 – 12 months of operating expenses in the bank for real financial security. Many small businesses make a fatal mistake of starting off with too little capital and not having the funds tucked away for unforeseen events, which have a habit of arising when you are at your most vulnerable. Investigate all available options so you have the capital at hand

Working Capital Loans – Essential for All Businesses

Of course, you could easily say that many of these loans actually decreases your working capital as you have to pay back this debt. All kinds of working capital loans have to be repaid, typically on a monthly basis, which is technically a current liability on your balance sheet.

But good business is about managing this debt carefully, in such a way that you are always cash positive. You can do this by not overextending yourself and making sure you have a healthy amount of working capital at hand so you are set for a bright future.

Working capital is essential for any business model. If you want to learn more about managing working capital and planning for long-term financial success, get in touch with Finimpact. We can help you take the right approach to financial planning. 

Daniel Lewis
Daniel Lewis
Daniel Lewis is an MBA accredited investment professional who wants to assist small business owners to gain access to finance. After going through many channels for funding, Lewis has found that getting the first loan right is vitally important for future success.