What’s the Difference Between a Business Line Of Credit And A Working Capital Loan?

It’s no secret that businesses need to have a steady supply of working capital on hand. They need financial security to be able to fund daily operations, support growth, or manage seasonal cash fluctuations.

Your business’s profit may seem solid, but it could still be experiencing inconsistencies from month to month. If you’re in a retail or a seasonal business, then things could be fluctuating more dramatically. In any case, your business will face consistent day-to-day expenses, despite whatever your company’s income may be. Sometimes emergency expenses come up. Other times, you may want to ramp up marketing. Whatever the case, businesses need money to mitigate or remedy these things and get back to running smoothly.

If you find your business in a situation like this, and don’t have sufficient working capital on hand to deal with it, a small business loan can help. Two common types of financing that businesses use for these situations are working capital loans and business lines of credit. If you’re not very familiar with these types of business loans, don’t worry! We’ll go over them both and more in the following sections.

Working Capital Loans

Working capital loans are a category of business loans that supply cash (or working capital) that businesses can use for any relevant business expense. This can be anything from usual, day-to-day costs to emergency expenses. They are also an alternative to traditional term and bank loans and differ in several ways.

You may be wondering if working capital loans are similar to traditional terms loans. A term loan is a traditional form of loan that provides funding for long-term uses. The set repayment term length will be at least a year. Most business owners use the proceeds of term loans to finance a specific, one-time investment for their small business.

Working with banks can be difficult and time consuming for small businesses. Fortunately, with working capital loans, you can go through private business lenders. This way, the process is quicker and easier, and the qualifications are not as strenuous. Additionally, working capital loans allow you to get that much-needed financing quickly. Private lenders can also offer more customized options for applicants. As we mentioned at the beginning of this section, several different financing options fall under the umbrella of working capital loans. Let’s detail a few of them.

Short Term Business Loans

These loans are just how they sound, for short-term expenses. You’ll receive a lump sum of cash and pay it off just like a regular loan, only you can get these more quickly and the timeframe of repayment is quick, usually a maximum of two years. Given the shorter timeframe, these payments are made weekly, rather than monthly.

Merchant Cash Advance

Merchant cash advances can help you get your capital quickly. An MCA isn’t technically a loan; it’s an advance. With an MCA, the business lender advances your business’s future credit and debit card revenues that you will repay in a predetermined daily percentage of your business’s credit and debit card revenues. In a nutshell, you will receive an upfront sum of cash in exchange for a percentage of your future sales. Fortunately, these are some of the easiest and quickest loans to acquire.

Accounts Receivable Financing

Accounts receivable financing lends itself to quick cash by allowing businesses to get early payment on their outstanding invoices. A company using this method of funding sends some of its unpaid invoices to a funder for advance payment in return for a fee.

Accounts receivable financing (A/R financing), sometimes known as a ledgered line of credit or invoice financing, is an excellent solution for businesses that need more funding that is not available from traditional lenders. A/R financing provides businesses with flexible and immediate cash that will help it grow, restructure, take advantage of supplier discounts, hire additional employees, or even to fund payroll.

Business Lines of Credit

Firstly, a business line of credit is a type of business financing. It’s a revolving line of credit that one can draw against on an as-needed basis. It can also be used for short-term working capital to help improve cash flow or to finance the costs of surprise expenses. A small business line of credit is revolving, and this is the primary distinguishing characteristic. Another characteristic is that a subsequent draw(s) taken after the initial funding are only restricted by the approval amount and not a pay-down requirement. In other words, the small business can access the line of credit as long as the small business has not hit its high credit limit.

A small business line of credit is very much like a credit card in the way funds are accessed; however, the way it is paid back usually differs from the way a credit card is paid back. Unlike a term loan (where a specific amount is paid back over a defined term), a line of credit allows the small business owner only to borrow the amount needed at any given time. This type of funding helps mitigate the ups and downs of cash flow, especially while waiting to collect on receivables.

There is more than one type of small business line of credit. Generally, these lines are categorized as either secured or unsecured. A secured line of credit is backed by collateral. This collateral could be inventory, equipment, real estate, or some other asset with a market value high enough to justify the credit limit. The other, a probably more popular type of line of credit, is an unsecured line of credit. This type of small business line does not require any assets of value to be pledged to establish the credit line. An unsecured line of credit is based on the cash flow and debt ratio of the small business, as well as the credit of the business owner or owners and the business credit of the entity itself.

The flexibility of a line of credit is attractive, but it doesn’t mean that it always makes sense to establish a line of credit. A small business line of credit has a few drawbacks. For example, the most apparent disadvantage is the amount of funding. A small business line of credit will usually have a lower amount offered than a small business loan. If a business owner(s) need access to a large amount, a working capital loan or term loan will probably make more sense.

The Takeaway

Business lines of credit and working capital loans are two common types of business financing. They both offer a quick and effective solution to gaps in cash flow, sudden emergency expenses and day-to-day costs. There are various financing options under the working capital loan category and there are a couple of variations of business lines of credit. Each brings its own benefits and drawbacks, so it’s important to do your research if you’re considering and choose what is most appropriate for your financing needs.

Crestmont Capital offers working capital loans and business lines of credit. If you’re interested, want to learn more or have any questions, feel free to contact us!