What is Working Capital? Types of Working Capital Loan

If you are trying to decide what loan to take out for your business, you might be overwhelmed with the information you find when doing your research. There are several different kinds of working capital available, although many assume there’s only one type of business loan. First, we will start by defining what working capital is.

What is Working Capital?

Working capital is a loan that is taken to finance a business’ everyday operations and expenses. These operations include payroll, rent, and debt payments. A working capital loan is a way for your business to be able to temporarily pay for these expenses if your cash is running low. This gives you time to catch back up through sales, invoices, or investments.

Working capital is the difference between your current assets and current liabilities and is used to cover everyday business expenses. It’s important because this money left over is how much money you have left to run your business after you’ve accounted for your liabilities. If you have a positive working capital, you can pay off your debts and still run business operations and purchase inventory. If you have negative working capital, you may find it difficult to run your business, pay debts, and purchase inventory.

There are a few different types of a working capital loan. Finding the right working capital requires you to know your business well.

Types of Working Capital Loans

  1. Bank overdraft and loan facility: this type of working capital loan lets you withdraw a large amount from your checking account. The loan terms of a bank overdraft are based on your credit history and relationship with your bank. The advantage of this credit over the others is that the borrower pays for the interest applicable to the amount that has been overdrawn. A bank overdraft is the most flexible working capital loan.
  1. Short-term working capital loans: a short-term loan comes with a fixed interest rate and payment period. The repayment period for the loan is typically 12 months. You may be able to get a short-term loan without any collateral if you have a good relationship with the lender. Short-term working capital loans are easy to qualify for and is a good option for newer businesses.
  1. Accounts receivable loans: to pay for a working capital loan you can always use your account receivables or your confirmed sales orders to apply.
  1. Factoring: this is where a business sells either all or some of its account payables to a third party at a low price. The third party here is known as the “factor” who provides factoring services to business. It provides financing by purchasing the bills and collecting the amount from debtors.
  1. Trade creditor: a trade creditor working capital loan is a loan provided by a present or potential supplier. If you place bulk orders, suppliers will offer a trade credit facility.

Reasons to Get a Working Capital Loan

  1. You will be prepared to handle any unexpected financial difficulties
  2. Inconsistent cash flow – a working capital loan will give you access to cash when your cash flow is low.
  3. Growth spurts in business – working capital loans can help new businesses cover everyday expense, hire employees, and pay employees when needed.
  4. Business opportunities may arise – your business can take advantage of any business opportunities that may arise with a working capital loan. Whether you need new equipment or need to invest in training, you can do so.
  5. No collateral required – unsecured working capital loans are given to those businesses who have good credit history or no risk of default. If this is the case, you won’t need to put up your business as collateral.
  6. They are quick – applying for a typical personal or business loan can be time consuming and in the end you may not get approved. With working capital, borrowers are able to access the cash almost immediately after the application is accepted.

Questions to Ask to See If a Working Capital Loan is Right for Your Business

  1. Have I explored all options? – thoroughly do your research and weigh your options before applying.
  2. How will I use the money? – you must have a plan and clear idea of how you want to use the money for your business.
  3. Can I afford the payments? -  if you can’t afford the payments, you will be in financial trouble and debt.
  4. Will this help my business financially? Consider if the loan’s benefits outweigh the costs of the loan.
  5. Do I understand the cost of the loan? – make sure you know all the fees and rates associated with the loan and that you are getting the best deal.

There are many different types of working capital loans out there. You should consider your business’ credit history and monthly deposits which will determine your loan eligibility. Also, make sure to get a few different quotes to get the best rate possible.