6 Types of Working Capital Loans Ideal for Small Businesses
Small business owners often need to find working capital for their companies. Whether it’s to pay bills, make payroll, buy inventory, purchase equipment or invest in future growth, businesses need a steady supply of working capital to manage their cash flow and capitalize on opportunities as they arise.
Here are a few of the most common varieties of working capital loans and how they can help your business:
Small Business Loan: The traditional small business bank loan is often viewed as a typical option for business owners to get working capital. However, especially in recent years, many small business owners have found it more difficult to get access to small business loans from traditional banks, particularly if the business owners do not have perfect credit or a long track record of being in business. Banks also are often reluctant to lend the smaller loan amounts that are typically needed by small business owners, preferring instead to issue larger business loans.
Credit Cards: Many small business owners borrow money for their business by using personal or business credit cards. Credit cards are a type of revolving credit account, which means that they can be used in a flexible way – you can borrow as much or as little money as you need, and then pay off as much or as little as you can afford to repay each month (as long as you make your minimum payments). One drawback of credit cards is that they often have credit limits that are too small to effectively fund big business needs – and their interest rates often make this form of borrowing more expensive than other working capital loans.
Small Business Line of Credit: With a small business line of credit, your business gets authorized in advance to be able to borrow a certain amount of money up to a certain credit limit or maximum loan that the lender will allow you to borrow. A line of credit works in the same way as a credit card – you get approved in advance for the amount that you are allowed to borrow, and then you can borrow money as needed, up to that maximum credit limit.
Home Equity Loans: Some small business owners can borrow money to help their business by tapping into a home equity loan or by borrowing against the value of real estate owned by the business. Interest rates for these loans are often lower than other options, since the loan is secured by real estate. However, one drawback of this type of working capital loan is that the borrower is forced to risk losing a piece of property (or even the family home) in case of default on the loan. Think carefully before risking your home – there might be better options to get the cash that your business needs.
Accounts Receivable Financing: Accounts receivable financing, also known as “factoring,” is a method of getting working capital that involves trading your accounts receivable to a “factor” which then gives you immediate cash based on the expected value of your future sales (once your customers pay in full). Factoring is a valid option for getting cash, but it can be challenging to get the fullest value for your accounts receivable, unless your customers are big corporate clients with strong credit ratings.
Personal Loans/Equity Funding from Investors: Many small business owners turn to their personal networks of friends and family to borrow money or raise capital, especially when starting a new business. It might make sense to turn to your inner circle first when needing to raise money – after all, these are the people who know you best and who believe in you the most. But mixing friendship with business can be risky! What if your business fails or loses your friends’ investment? It might be better to borrow money from the open market and keep your most important personal relationships separate from your business life.
There are a variety of options for working capital loans, and they each have their unique costs and benefits. Before committing to a source of working capital, be sure to evaluate your options carefully and look at the big picture of what your business needs. Ideally, your working capital source should help your business be better off than it was before, with the right degree of flexibility and the right size to fit your business objectives.
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FAQs
The three types of working capital loans in India are: Short-term or long-term working capital loans. Unsecured working capital loans. Secured working capital loans.
Which type of loan is ideal for businesses who need fast working capital and are seeking smaller loan amounts on shorter terms? ›
Key takeaways. Working capital loans are short-term loans that are best for covering gaps in cash flow for expenses related to your business's day-to-day operations. This can include rent, payroll, utilities or inventory.
What is working capital for small businesses? ›
A short-term loan that is used to finance day-to-day business operations such as managing payroll, stocking inventory, manufacturing products, paying debts, and so on can be termed as working capital loan.
What is a working capital loan? ›
Working Capital Loan: This type of loan is specifically designed to address short-term cash flow needs for day-to-day operations. It's often used to cover expenses like payroll, inventory restocking, or paying bills.
What type of loan is working capital loan? ›
A Working Capital Loan is one that is availed of to fund the day-to-day operations of a business, ranging from payment of employees' wages to covering accounts payable. Not all businesses see regular sales or revenue throughout the year, and sometimes the need for capital to keep the operations going may arise.
What is the most common type of financing for small to medium sized businesses? ›
SBA loans are among the most popular types of small business loans, but they have an involved application process. Even so, they are a good option for working capital, big expenses or growth opportunities. Most business owners will likely benefit from applying.
What type of financing do small businesses use? ›
Small businesses typically use debt or equity financing — or a combination of the two. Debt financing involves borrowing money from a third party, which you then repay, with interest. Equity financing, on the other hand, means you receive money from an investor in exchange for partial ownership of your company.
What is the most common form of financing for a small business? ›
Term loans
A business term loan is one of the most common types of business financing. You get a lump sum of cash upfront, which you then repay with interest over a predetermined period of time. Payments are fixed, usually on a monthly basis.
Which is the best example of working capital? ›
For example, say a company has $100,000 of current assets and $30,000 of current liabilities. The company is therefore said to have $70,000 of working capital. This means the company has $70,000 at its disposal in the short term if it needs to raise money for a specific reason.
What are the 4 components of working capital? ›
A well-run firm manages its short-term debt and current and future operational expenses through its management of working capital, the components of which are inventories, accounts receivable, accounts payable, and cash.
Factors that determine your creditworthiness usually include your credit profile (your personal FICO Score and business credit score), time in business and annual revenue. Some working capital loans also require a personal guarantee or collateral, such as with secured business loans.
What is the interest rate for working capital loan? ›
Interest Rate and APR Calculator
| Product | Minimum | Mean |
|---|
| Working Capital Loans | Repo + 2.50% | Repo + 3.17% |
Working capital loans are usually unsecured loans. However, a higher amount of credit lines may require some kind of collateral. The tenure is usually between 6 – 12 months and comes with an interest rate of 11-16%. When should you go for a Working Capital Loan?
Are working capital loans a good idea? ›
Summary. Working capital loans are a form of debt financing meant to cover short-term financial needs, such as capital expenditures. A working capital loan can be an effective way to remain agile as an organization and respond to unforeseen opportunities by securing additional financing.
What are the 3 working capital financing policies? ›
Working capital financing policies are critical for a company's financial health. They determine the balance between short-term assets and liabilities. Three common policies are aggressive, conservative, and matching, each with distinct characteristics and implications.
What is another name for a working capital loan? ›
Working capital loans (sometimes known as cash flow loans) are term loans that are typically used to fund longer-term investments or purchases.
How many sources of working capital are? ›
Sources of working capital
Long-term working capital sources include long-term loans, provision for depreciation, retained profits, debentures, and share capital. Short-term working capital sources include dividend or tax provisions, cash credit, public deposits, and others.
How many main types of loans are there? ›
What are the different types of loans?
| Loan type | Purpose | Collateral required |
|---|
| Home equity loan | A wide range of purposes including home improvement projects and medical bills | Yes |
| Student loan | To pay for a post-secondary education | No |
| Auto loan | To finance a vehicle | Yes |
| Small business loan | To fund your business expenses | Yes |
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