What is a working capital loan, and why do you need it?

Finance management teams that identify whether their organizations can withstand an unexpected crisis or downturn usually monitor two metrics. These metrics include cash flow and working capital. Both of these metrics demonstrate different aspects of the company’s financial health.

Cash flow here measures the capital that a company has consumed and generated within a certain period. However, on the other hand, working capital is the difference between the company’s current assets and current liabilities.

Current assets here will include everything from cash to the assets that you can convert into cash within one year. At the same time, the current liabilities include accounts payable, payrolls, and other accrued expenses of the organization.

Everything you need to know about working capital loan

Any organization that can maintain its working capital positively usually has higher chances of withstanding any financial challenge and the flexibility to invest in the business growth.

However, if you don’t have enough working capital for your business, you can get a working capital loan. To know more about what a working capital loan is and why you may need it, let’s look at the details below. This guide will surely let you have a better idea about things in this regard.

So, here we go:

What do you mean by a working capital loan?

So, the working capital loan is a type of financing a business can get to pay for its day-to-day operations. A working capital loan can be used to cover payrolls, restock inventory, stay current on rent, and more. Typically, credit unions, traditional banks, and online lenders offer working capital loans to businesses.

  1. The annual percentage rates are lower as compared to long-term loans. However, still, these range anywhere between 3 to 99 percent.
  2. On top of that, qualification requirements for working capital loans are also less stringent as compared to long-term loans, especially when you get them through online lenders.
  3. Additionally, working capitals are easy and fast to secure, generally. Therefore, business owners can use these to address their immediate financial needs quickly.
  4. They receive all in a lump sum at once, increasing the funding impact.

In short, the working capital loan is an ideal debt option for seasonal businesses and to manage other operations that require short-term access to the funds.

Why do you need a working capital loan?

You need to get a working capital loan when you are struggling to cover your everyday operational costs. Additionally, you can also apply for a working capital loan when you need finances for your temporary expenses for payroll, supplies, or inventory.

Keep in mind that you can’t use a working capital loan to cover the long-term expenses of your business. For example, if you are planning to expand your business or need some capital to buy expensive equipment, then you should get a business loan instead.

There are certain situations where a business owner can apply for a working capital loan. These include:

  1. When you require some money to cover rent or payroll until you have paid your outstanding invoices already.
  2. If your business sales are cyclical or seasonal, and your business is experiencing an annual dip in revenue. Then you can consider applying for a working capital loan for your business.
  3. On the other hand, even if the manufacturing needs of your business have become greater during the months of low revenue. It means you can get a working capital loan if you are unable to cover production costs because your finances are tight.

So, these are the situations when you will need to get a working capital loan for your business. However, it is always important to perform your due diligence before applying for a working capital loan.

Tips for getting a working capital loan

Do you want to know how to apply for a working capital loan? Here are some tips that you should consider in this regard.

So, here we go:

1.     Understand your needs

If you feel that your business can take advantage from a working capital loan, then you must spend some time to evaluate your business needs. It will let you know the amount you have to borrow and for what duration.

2.     Check credit scores of your business

If your business has a credit profile, then always remember that potential lenders will evaluate it. Therefore, it is important to check your credit scores to evaluate the odds of your approval. So, ensure to manage a personal FICO Score 530 at least to qualify for it.

3.     Research different lenders and compare them

Once you understand how much money you will need, then you should start searching different lenders’ options. Research lenders with qualification requirements and loan amount to find the best fit for your needs. Compare different banks, online lenders, and credit unions based on different parameters. These usually include repayment terms, interest rates, and other fees.

Also, make sure to spend some time reading customers to determine the reputation of each lender more effectively. This will ultimately help you to shortlist your best options with ease. As a result, proceeding further will also become easier for you.

4.     Complete required documentation

Documents required to apply for a working capital loan may vary from lender to lender. However, in the majority of cases, you will require to provide information about your prior business loan along with submitting at least 12 months of the business bank and personal statement. Tax returns for about two years, the minimum is also important.

5.     Submit your formal loan application

Once you have ready all the documents for your working capital loan, you need to fill and submit a formal application through an online lender, online or by visiting a branch.

Final Remarks to make a decision

The procedure varies for each lender. However, most commonly, you will be contacted through email or a phone call once your loan application is going to get approved. You can also check the status of your working loan application online to know about it.

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