What Are Working Capital Loans and Why Are They Important?

Introduction

Working capital loans are short-term loans that are used to finance daily business operations. While these loans are not intended for acquisition of long-term assets or investments, they can ease the handling of day-to-day expenses. Routine operational costs of a business may vary across businesses but in general, they are categorized into fixed and variable costs.

Fixed costs include expenses such as rent or employee wages while utilities (electricity, water, production costs etc) are covered under variable costs. As you increase awareness about your product or service, you also require working capital for advertising and marketing campaigns. You may also use them towards inventory purchase.

Why Working Capital Matters

With rising inflation rates and an unfriendly economy, many businesses are unable to generate the revenue required to fund their daily operations. As a result, business owners are often stressed out over stretching their funds to cover their business operations while funding other aspects of their business.

A working capital loan can help tide you over until your business gains a firm foothold and you are able to meet your day-to-day operational expenses. This can give you some much-needed breathing space during which you are able to continue business operations despite an inability to cover related operational expenses.

A significant cash infusion can make a huge difference to business performance. Gaining access to adequate capital can help you accept new orders that require increased production capacity or power up your marketing campaign to increase sales.

When Do You Need a Working Capital Loan

You could require a working capital loan under different circumstances. These include starting a new business, during expansion or for restructuring your current business. Seasonal businesses also need funding to help them stay afloat during lean seasons.

For example, a ski equipment rental business may require external funding to keep them operational during summer months.

Most lending institutions will require your company’s credit history, cash flow details and projected revenues to approve your loan application. Loan approvals can take as long as 2 to 3 months.

Types of Working Capital Loans Available

You can gain access to different types of loans, depending on your profitability levels and credit history.

Debt Financing

This is a great way of gaining access to working capital for those businesses that have run into debt and require funds for daily operations. However, you might want to be aware that debt financing institutions often have stringent criteria for loan approval and the process tends to be long-drawn and complicated.

Equity Financing

You can also generate revenue by selling shares in your company to interested investors. Some businesses also offer a percentage of ownership to potential investors and use the cash infusion to fund their business operations.

While this is a good way of generating revenue, you are forced to share ownership (and profits) with other investors.

Special Government Subsidies

Certain businesses enjoy the patronage of government subsidies that offer them loans at attractive rates. Businesses that are perceived as good for the country’s economy get preference for approval. For example, export businesses can often get approved for government subsidies.

Repayment Methods

Working capital loans can be typically repaid in one of two ways. One is by offering a small percentage of sales towards repayment. This percentage/amount is decided at the time of application between the lending institution and the applicant.

Another way of paying off the loan is to pay a small amount on a daily basis from Monday through to Friday. This method of repayment helps you build up a respectable credit history and reduces stress levels.

There are several online lending companies that offer to approve loans within a few days or even within a few hours. Before getting tempted to sign on with them (the terms are often attractive and extra costs may be cleverly hidden in the clauses), make sure you understand their terms clearly.

Remember that no-one will lend money without making a profit out of it. While government agencies may take a long time for approval, they are reliable and upfront in their dealings.