What is a Working Capital Loan? And How Can I Get One for my Business?
Working capital is the money a business uses to cover its daily expenses like utilities, supplies, payroll, and rent. A working capital loan offers your business a way to temporarily pay for these expenses when your bank account is running low.
You might think that if your business is successful and you manage its finances correctly, you could never have need of a working capital loan. But that’s not necessarily true. Maintaining a balance of cash on hand can be a challenge.
While it’s important to keep some money in reserve, you don’t want your company’s financial safety net to grow too large either. Save too much money (like Scrooge) and you could miss some valuable opportunities to invest in your business and potentially grow.
But what happens when an investment goes wrong or you don’t collect on invoices as quickly as you anticipated? What if your company’s sales cycle is seasonal and you have an unexpected expense come up during a slow income month? When funds are tight and cash flow is low, a working capital loan may help your business cover those everyday operational expenses until online payday loans Edon same day your business has a chance to catch up through sales, invoices, investments, or other means.
What Are Working Capital Loans?
As mentioned, a working capital loan is a type of business loan that can help when your company finds itself in a tight financial spot for whatever reason. This form of business funding isn’t used for long-term investments but rather is reserved for short-term financial goals.
Before we review the different types of working capital financing options available, let’s back up and better understand working capital itself-how it’s defined and how it’s calculated.
Working capital (also called net working capital) is the difference between your business’ current assets and its current liabilities. Assets may include accounts receivable, inventory, and cash on hand. Liabilities may include accounts payable and any payments due on business debts in the next 12 months.
The Security Exchange Commission describes it this way: “Working capital is the money leftover if a company paid its current liabilities (that is, its debts due within one year of the date of the balance sheet) from its current assets.”
- Current Assets – Current Liabilities = Working Capital
Let’s illustrate this formula. Your business has $1 million in assets, including cash, accounts receivable, and inventory. It also has $750,000 in liabilities in the form of outstanding accounts payable and other debts.
- Current Assets ? Current Liabilities = Working Capital Ratio
So, if you have assets worth $1 million and liabilities totaling $750,000, the working capital ratio of your business is 1.33. According to QuickBooks , your business should aim to have a working capital ratio of 2:1, so in this example, your ratio is a little low and might indicate you don’t have enough of a cushion in your business bank account.
Working Capital Loans
Cash flow issues can be incredibly stressful for any small business owner. It can, in fact, be the cause for small business failure: 82% of the businesses that fail do so because of poor cash flow management .
And while business credit cards can offer a quick way to pay for an unforeseen expense, they often come with large interest rates. A better option? Working capital financing.
Working capital loans can offer an immediate influx of cash to help your company cover expenses during an emergency or downturn in business. These short-term loans won’t keep you afloat forever, of course, but they can help to stop the bleeding until you’re able to find a more permanent solution to solve your business’ cash flow problems.