Working capital loans: Are they right for your business?
Working capital loans
- Can be secured or unsecured
- Used to fund short-term operational expenses
- Options include line of credit, cash advance or invoice factoring
If your business is cyclical or seasonal, and sales are stagnant at certain times of the year, you may need financing to help the business meet its financial obligations when sales are slow.
Working-capital loans are one option for such businesses, but how do they compare to other alternatives, such as lines of credit, cash advances or invoice factoring? Take a look at each of the options below to see which one is right for your business.
Working capital loans
Working capital is the cash a company has available to finance short-term operational needs. If the company doesn’t have enough cash on hand to cover daily operational expenses, they may opt to take out a working capital loan, used by companies to finance daily operations. This can be useful for companies that don't have stable revenue coming in throughout the year.
Working-capital loans are a form of short-term financing that can help pay wages and other operating expenses in times of low sales volume. The company is then typically able to repay the loan by the time its business picks up.
Working-capital loans are available in either secured or unsecured forms, although unsecured loans are usually only available to businesses with good credit.
Lines of credit
A line of credit is essentially a loan with a predetermined maximum amount. Interest is typically not charged until the line of credit is used, and interest will only be charged on the amount used.
A personal line of credit can be an inexpensive, flexible borrowing option for business owners. Personal lines of credit typically carry lower interest rates than credit cards, and are a flexible source of revolving credit, meaning you can carry a balance from month to month.
A line of credit can be used to help pay expenses during a company’s downtime, similar to a working capital loan. In fact, some banks advertise business lines of credit as a working capital solution. A line of credit also may offer lower interest rates than a working-capital loan.
One of the most common forms of cash advance used by businesses is called a merchant cash advance. Merchant cash advances can be a costly borrowing option, however, with annual percentage rates that can be in the triple digits.
Merchant cash advances are usually used by businesses with a lot of credit- and debit-card sales. The merchant cash advance provider will provide a lump sum to the business in exchange for a percentage of future sales. The repayment is typically structured with fees, which are calculated as a multiple of the amount advanced. That multiple typically ranges from1.2 to 1.5, so a $25,000 advance at a multiple of 1.5 results in a total repayment of $37,500 — or $12,500 in fees spread out over the course of the repayment.
Because of the high cost associated with these kinds of cash advances, they should generally be reserved as a last-resort alternative to other borrowing options, such as working-capital loans.
Invoice factoring deals, like merchant cash advances, are technically not loans. If your business has customers who won’t be paying you until a future date, but you need cash immediately, invoice factoring allows you to sell your invoices at a discounted rate to an invoice-factoring company that will pay you cash.
Like merchant cash advances, the cost of invoice factoring can add up quickly. If other lending options have proven elusive, invoice factoring might work as a last resort.