Working capital is the money a business uses to cover its daily expenses like utilities, supplies, payroll and rent. A working capital loan offers your business a way to temporarily pay for these expenses when your bank account is running low.
You may think that if your business is successful and you’re managing to balance your finances correctly, you’ll never need a working capital loan, but that is not necessarily true. Maintaining a balance of cash on hand can be a challenge.
While it is important to keep some money in reserve, you do not want your company’s financial safety net to grow too large. Save too much money and you could miss some valuable opportunities to invest in your business and potentially grow.
But what happens when an investment goes wrong, or you do not collect on invoices as quickly as you anticipated? What if your company’s sales cycle is seasonal and you have an unexpected expense come up during a slow income month?
When funds are tight and cash flow is low, a working capital loan may help your business cover those everyday operational expenses until your business has a chance to catch up through sales, invoices, investments or other means.
What Are Working Capital Loans?
As mentioned, a working capital loan is a type of business loan that can help when your company finds itself in a tight financial spot for whatever reason. This form of business funding is not used for long-term investments, but rather is reserved for short-term financial goals.
Before we review the different types of working capital financing options available, let us back up and better understand working capital itself, how it is defined and how it is calculated.
Working capital (also called net working capital) is the difference between your business’s current assets and its current liabilities. Assets may include accounts receivable, inventory and cash on hand. Liabilities may include accounts payable and any payments due on business debts in the next 12 months.
The Security Exchange Commission describes it this way: “Working capital is the money left over if a company paid its current liabilities (that is, its debts due within one year of the balance sheet date) from its current assets.”
Here is the formula you need to follow to calculate your business’ working capital:
Currents Assets – Current Liabilities= Working Capital
Let us illustrate this formula. Your business has $1 million and liabilities totaling $750,000. The working capital ratio of your business is 1.33. According to QuickBooks, your business should aim to have a working capital ratio of 2:1, so your ratio is a little low in this example. It might indicate you do not have enough of a cushion in your business bank account.
Working Capital Loans
Cash flow issues can be incredibly stressful for any small business owner. In fact, it can be the cause for small business failure: 82% of the businesses that fail do so because of poor cash flow management.
And while business credit cards can offer a quick way to pay for an unforeseen expense, they often come with large interest rates. A better option? Working capital financing.
Working capital loans can offer an immediate influx of cash to help your company cover expenses during an emergency or downturn in business. These short-term loans will not keep you afloat forever, of course, but they can help until you find a more permanent solution to solve your business’ cash flow problems.
Working Capital Short-Term Loans
Since business capital is generally used for your business’ daily expenses, loans designed to help cover these costs will typically have shorter payback terms. Often short-term loans, sometimes called cash flow loans, must be repaid to the lender within one year or less.
Such loans are not meant to cover long-term investments like real estate or expensive equipment purchases. They tend to have higher interest rates than business loans designed specifically for equipment or real estate, as well as those short repayment periods.
Always review the costs, loan terms and conditions of any financial product carefully before filling out an application.
Working Capital Lines of Credit
Do you want the flexibility to borrow only as much money as you need, pay it back as soon you can, and then borrow from the same source again in the future without filling out a new application? If this type of borrowing freedom appeals to you, you may want to investigate opening a line of credit for your business.
A working capital line of credit, also called revolving credit, can give companies access to a constant supply of funds. Even businesses that are not experiencing any cash flow problems may benefit from having a credit line in reserve.
Just remember, before you sign up for any type of business financing, lines of credit included, be sure to read the fine print.
Working capital lines of credit may come with high-interest rates, lower loan amounts, or aggressive payback terms. It all depends upon your credit, the lender and other business factors.
If a working capital line of credit interests you, please contact a representative at Porter Capital.
Working Capital Loans for Startups
Startup companies can be particularly vulnerable to cash flow problems as it often takes a new business some time to start generating sufficient cash flow to cover expenses. Working capital business loans can be a great tool to help startups navigate this challenging time.
Porter Capital’s take on Working Capital Loans
There is no question that cash flow problems can be crippling to business success.
If your business is struggling month to month to find enough working capital to pay expenses, it might be time to try and figure out how to make some big changes in either your company’s expenses, income, or both.
However, if you simply need a one-time, immediate influx of cash to make it through a rough patch, working capital financing may be exactly what your business needs.
If you need more information to get started with Porter Capital, please contact us at 1-800-737-7344.