Everything You Need to Know About Working Capital Business Loans

24 Nov, 2016 / Comments: Comments Off on Everything You Need to Know About Working Capital Business Loans / By

One important indication that your business is successful is how much money you are making. Of course, in order to run your business, you need to use this money to pay your rent (if you don’t own your store outright), insurance, utilities, vendors, any materials you need, if you make your products, plus the wages of your employees. Even if your business is booming, a working capital business loan can help you to expand by giving you the capital you need.

 

What is Working Capital?

Working capital is essentially the difference between your current assets and liabilities. Assets include everything that is in your store that can be bought and turned into money, including the actual money you already have, within a 12-month timeframe. Your liabilities, on the other hand, are all your debts related to your day to day expenses, including utilities and payroll, for that same 12-month timeframe. For example, let’s say you have a small business with $2,000 in cash and $5,000 worth of products on your shelves. Your assets total $7,000. After you’ve added all your debts, those total $4,000. Your working capital is therefore $3,000.

 

Why Get Another Loan?

Even if you already have a small business loan, a working capital business loan is different. Small business loans are used so that you can invest in more assets to help your business grow. A working capital business loan, however, is for the money you spend on daily expenses. Why, if your business is successful, you might ask, would I want to get another loan?  Easy, these loans are used to cover short term situations. For example, maybe your business is seasonal, and you know that you are going to be slow in the wintertime. You still want to keep your doors open to welcome any visitors who may stop in, but you aren’t going to be making that much money during those months. A working capital loan allows you to still keep your lights on and pay your employees without depleting your positive working capital, or worse, sending you into the red.

 

There are several other reasons to get a working capital business loan. For instance, you might suffer unexpected losses while trying to market your business or when you are trying to hire and train new employees. Perhaps you’ve been presented with a new business opportunity that won’t pay right away. You might have clients who don’t pay right away, and a working capital business loan can help cover the inconsistencies. Or, maybe you just need extra cash, just in case.

 

Is There More than One Type?

There are a few different types of working capital business loans. A line of credit is an excellent option if you aren’t quite sure how much money you need when you want to get one. They don’t require an application, and, like a credit card, you can borrow up to a set limit. Other types of working capital business loans include short-term financing and invoice financing loans. Short-term loans are paid back within a short period of time, rather than being stuck with a long-term repayment plan for something you only needed for a brief period of time. An invoice loan, on the other hand, helps when you have inconsistent clients. The loan company pays for the client’s bills upfront while you wait for the actual client to make their payment, allowing you to keep your business running smoothly. After all, you can’t stop your business waiting for one or two clients to make their payments.

 

Sounds Great, What’s the Downside?

While working capital business loans have multiple advantages, there are a few downsides that you should consider as well. First, you do have to have some collateral in nearly all cases. After all, your bank needs to know that you’re going to make good on paying them back. Secondly, working capital business loans often have higher interest rates than other types of loans, often between 12-16%. If you start taking out multiple loans, your credit score could be impacted. Finally, and most obviously, you do need to pay the loan back.

 

So, Is it Right?

Before you head out to apply for your working capital business loan, take the time to consider if it is the right course of action for your particular needs. Make sure you’ve explored all your options first. Can you cut costs somewhere, or do something else to improve cash flow? Think about how you plan on using the money. Make sure you have a plan before applying. The money is for short-term solutions, not long-term. Finally, consider how the loan will impact your business. You want to be certain that it will have a positive impact, not send you into a downward spiral as you try to repay it. You want your outcome to be beneficial.

 

A working capital business loan is one of the easiest ways that you can ensure the success of your business and even help it grow. If you have considered all of the benefits and drawbacks, and a working capital business loan sounds like the best option for you, it just may help your business stay afloat or even flourish.

William Mahnic
William Mahnic is a Finance Professor at Case Western University and has spent more than 20 years in the finance industry before becoming a professor. Mahnic has appeared as a commentator on both TV and radio talk shows including NPR, Crain's Cleveland Business, WKYC 3 and The Washington Post. He has been interviewed in BusinessWeek, Wall Street Journal and The Los Angeles Times.

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