Did you know that 82 % of businesses fail because they have poor cash flow management skills? These failures are not always caused by a lack of revenue. Cash flow problems are more likely to occur when customers pay late or in emergencies.
Working capital is the money that your business uses to pay for its operational costs. Working capital loans can help you bridge a gap in your cash flow, so that you can cover expenses until the cash flow issue is resolved. We’ll discuss working capital and how to obtain a working-capital loan.
Why is it important to have a working capital?
The term refers to the operational costs of a company, including payroll and inventory. This term can also be used to describe the cash reserve that you have available in case your business is facing a difficult time. Lack of working capital can lead to a business’s failure because it cannot cover its daily expenses.
What is a working capital loan?
Working capital loans are small business loans that help you fund your everyday business expenses. Working capital loans are used by many business owners to pay rent, payroll and to fill in cash flow gaps during periods of low sales. Read our blog to find out more about working capital loans.
How to Get a Working Capital Loan for Your Small Business
There are many types of loans for working capital available to small businesses. However, you should be cautious when selecting your loan. If you choose a financing solution that does not suit your business’s needs, you could end up borrowing more money than you need to or paying high interest rates. This guide will help you find the best types of working capital loan for your business.
1. Evaluate your working capital needs
The working capital formula can be used to determine how much money your business has.
Working capital = Current Assets minus Current Liabilities
The current year’s figures are used.
If your liabilities exceed the value of current assets, you may have a problem with working capital. This equation will help you determine how much capital you currently have. It should also give you a good idea of how much capital you’ll need to run your company smoothly.
2. Select the right type of working capital loans for your business
Working capital loans come in five different types, each with its own advantages and disadvantages.
Line of Credit
You can borrow up to the credit limit and repay it when you need. You can borrow as much credit as you need and repay it to get back your credit. This working capital loan offers flexibility. You may be limited to the amount you can borrow through a line credit.
SBA loans
SBA loans are offered by the Small Business Administration. SBA loans range in amount from $500,000 up to $5.5million, which makes them a great source of money if you are short on cash. Also, their interest rates are capped. SBA loans are subject to a long approval process, and collateral may be required.
Short Term Loans
Online, many alternative lenders provide short-term loans. You can borrow up to $5000 with a repayment period of three years. These types of working capital loan have a faster application process and less strict eligibility criteria.
Merchant Cash Advances
You can repay your loan by using a percentage of your debit or credit card sales. This may seem like an inexpensive way to pay back your loan, but lenders charge a fee which can make it one of the most expensive types of working-capital loans.
Accounts Payable Loans
Your accounts receivables are used as collateral. Your lender will pay up to 80% face value for your receivables. You lose 20% of your accounts receivables as repayment.
3. Know your lending options
When applying for a working capital loan, you have several options.
- Government Institutions
- Banks
- Online lenders/Alternative lenders
- Peer-to-peer lenders
The track record of banks and government institutions is excellent. They also have stricter requirements and are slower to approve applications than alternative lenders.
4. Check your credit rating
Most lenders will require that you have a high credit score and a history of timely repayment of your previous loans or credit. A lender may reject your application if you have defaults in your credit history or a low ratio of your credit to debt. Check your credit report before applying for a mortgage.
5. Get Your Financial Documents
Your application must be accompanied by several financial documents. The documents you provide may include your income tax returns and annual revenue, which lenders will use to verify your company’s legitimacy. To speed up the application process, gather them before you apply.
6. Confirm if you require a collateral
If you default on the loan, your lender will collect collateral. Personal guarantees are a promise to repay debts if you default on them using your personal assets, without specifying the assets. Before applying, ask your lender whether they require collateral or a personal guarantee. You should be wary of lenders who require collateral because they put your assets at risk in the event you cannot make your repayments.
7. Work Capital Loans
Complete your application and send it to the lender along with all other required documents. Then, you just have to wait for the lender’s response. Online lenders have a much quicker approval process than banks.
8. Review the terms and conditions of the loan, including the interest rate, repayment schedule, and other terms.
If the lender accepts your loan application, he will let you know the terms and conditions of the loan. They should be evaluated thoroughly. Look at the interest rates to see if they make the repayment terms of the lender unfeasible. You can often negotiate a lower interest rate with your lender, especially if you are a good credit risk.
Another important consideration is the frequency of repayment. If you have to make more frequent payments than you expected, a loan could become less attractive. Ask about the term of the loan. You’ll be able to repay the loan faster if you choose a shorter term, but you will pay more each month or per week. When making a decision, consider which option is best for your company.
Compare quotes from two or more lenders
Never accept the very first quote that you are given by a lender. Compare quotes from different lending options. You may discover that the lender you initially thought was a good one charges a higher rate of interest than an alternative lender.
Select the Loan and Lender that Best fits Your Business Needs
Compare quotes and choose the lender who offers you a working capital credit that is suitable for your business. Also, make sure that repayment terms are reasonable.
FAQs
Who can apply for a loan to cover working capital?
Working capital loans are available to almost any small business. Startups are the only exception to this rule, as they do not have the track record of business that most lenders look for. Startups often have grants and other options for funding.
What is the working capital requirement of your business?
Ideal is to achieve a ratio of working capital (assets divided from liabilities) between 1.5-2.
Working Capital Ratio = Current Assets/ Current Liabilities
If you have a ratio higher than 2, it could be that you are underutilizing your funds. If your ratio is less than 1.5, it may be time to investigate the different types of working capital loan. Your company’s liquidity will be lower the lower your ratio. A low ratio will reduce the amount of money you can borrow for a working capital.
Commercial banks offer loans to cover working capital.
Commercial banks provide working capital loans. These loans have several disadvantages. Commercial banks, for example, have higher rejection rates and stricter eligibility criteria than alternative lenders. Some lenders even specify how to use their working capital loan.
