Working capital loan: How it works and why it is a good choice?
Doing business is never a straightforward way. Even if it faces some unpredictable situations and strongly needs funds, there is no need to close a business. Any temporary financial constraints may be easily covered using a working capital loan. In this article, we will reveal the most important benefits of this financing and why it is really worth attention.
Working capital loan at a glance
A working capital loan is a short-term loan aimed at providing cash to a business so it can cover all of its operational expenses in a timely fashion. This type of loan typically has a short repayment period but it is also provided very fast as well. However, under specific terms, these working capital loans can be long-term. If you need more information about what is working capital, feel free to contact professionals.
How to calculate working capital?
Before requesting a working capital loan, you should make some advance calculations. For this purpose, you need to know your working capital. This is the amount of money a company deals with while covering its daily operational costs and some short-term expenses.
To calculate your working capital, extract your current liabilities from the general amount of your assets. A positive difference signifies you have enough money to cover your daily expenses. A negative or very small difference is a signal you don’t have enough money to cover your daily business needs.
The said ratio, by the way, is also used to measure the liquidity and financial health of a business. For this purpose, you need only divide your current assets by your current liabilities. If this ratio is more than 1, this also means you have enough funds in possession to pay your bills. The best way is to keep the ratio somewhere between 1.2 and 2. However, if this ratio is less than 1, you can assess the actual deficit of your funds clearly. If you need more precise calculations regarding how much working capital your business requires, feel free to contact professionals for more detailed calculations.
How does working capital loan work?
Working capital loans are similar to many other types of borrowings. A business can get the sum of money it needs to cover operational costs as a lump sum or as a line of credit. Most often, a company repays money back over a short period of time — from 6 to 24 months.
In some cases, a lender can request bimonthly, weekly, or even daily payments. There may also be some special terms of financing under these circumstances. For instance, merchant cash advances envisage automatic repayment through a percentage of sales that a company has.
A working capital loan is a good opportunity in many cases. For instance, a business can use it to cover the gap during the seasonal business flow months to avoid a cash crunch or for financing a short-term project that can help a business in the nearest future already.
Reviewing the advantages and downsides of a working capital loan on balance
The immediate benefit a business enjoys when requesting the working capital loan is a very short-term term for getting money. It is very easy to obtain and cover swiftly any operational gaps that may be in place.
Another obvious benefit of this loan is its form of debt financing. This loan doesn’t require any equity transaction. This means that a business always remains in charge of its company and reserves full control over it. Yes, this is the case even if financing is dire.
Even more — some working capital loans are even unsecured. In this case, a company is not obliged to put down any collateral to secure the provided loan. On balance, it should be noted that only companies with a high credit rating are eligible to get this very beneficial type of unsecured loan.
In many cases, the collateralized working capital loan can be a significant drawback to the overall loan process. However, there may be many other drawbacks of this process in place. First and foremost, the interest rates may be high. Typically, they are higher compared to the terms of standard loans. On the other hand, the repayments under the working capital loan are split into small portions. So, they will not overburden a business. The high interest rate is justified by the same high risk that a lending institution bears when providing such a loan, especially if it is unsecured.
Another disadvantage that may be in place but it will touch a business owner first. The working capital loans are often linked to a business owner’s personal credit. This means that all payments missed or delayed will hurt the owner’s personal credit score. However, a business owner may greatly benefit from getting this type of loan, especially when fast actions are needed.
Overall, it should be noted that loans of any type never address the underlying issues. The working capital loan specifically is one designed to cover a temporary or seasonal shortage of funding. If you face the sharp need to get a working capital loan too often, a more detailed analysis of your financial situation and spending, including cash flow, is 100% required. It will encourage the changes towards your company’s financial stability and resilience to challenging situations.
Bottom line
A business may appear in different financial situations. If you feel it has faced severe constraints, there is no need to risk further. Prevent your business from failing just because it simply lacks funds to cover its operational expenses.
A working capital loan is a good solution helping to overcome fast and effectively any temporary financial constraints. This loan will facilitate your fast recovery and future business growth. Contact professional advisors for more details and precise calculations regarding the amount of working capital loan that will work for you.