How a Working Capital Loan Can Work for Your Business
Every business needs money to operate. And sometimes a business needs more money - when starting up or expanding. A working capital loan or line of credit is a good way to get money for your business and your up-and-down needs for money.
What is Working Capital?
Working capital is an amount of money borrowed from a bank or other lender and used by a business for money to keep operations going and pay business bills. A working capital loan is simply a loan that will give you this working capital.
When we talk about working capital what we really mean is CASH. It's cash to pay the bills while you wait for new customers. It's cash to pay for the construction of an expansion or for new products you want to sell. It's about cash flow, to keep your business afloat.
Working Capital Loans vs. Traditional Business Loans
A traditional business loan is a fixed amount of money to buy something specific, usually a business asset like a car or a new building, or even a new business. Business loans are for a fixed amount of money and they are usually secured by the asset. For example, a business loan to buy a building uses the building as collateral in case the loan isn't paid.
A working capital loan is usually not secured; it doesn't have any collateral behind it. A working capital loan may also be a line of credit, that you can take from as you need it.
The Importance of Working Capital
Working capital loans are used to help businesses function on a day-to-day basis. You might say that working capital is the life-blood of a business. No blood and the business stops going. That's a little dramatic but it emphasizes its importance. For many new businesses, having enough working capital means the difference between the success and failure of the business.
Having enough working capital for your business to function day-to-day is most important during the startup phase. At this point, you may have a negative net working capital, because money is going out faster than it's coming in. And you may decide you need a loan to cover your expenses while you work on getting to a positive working capital position - that is, having cash in the bank.
How Working Capital Is Valued for Accounting
Working capital on a business balance sheet includes all current assets: cash, accounts receivable, prepaid insurances, and inventory. These balance sheet items can be quickly turned into cash, if necessary, to pay current expenses of the business
As noted above, net working capital is a financial metric used to analyze the strength of a business. The ratio is current assets minus current liabilities = net working capital. A good ratio would be 2:1; twice as much in current assets as in current liabilities. A higher current asset number allows the quick sale of assets, usually at a loss, to pay off current liabilities.
From an accounting standpoint, net working capital is the difference between all the current assets minus all the current liabilities. Current assets are those assets you can turn into cash quickly, like accounts receivable. Current liabilities are those bills you must pay now or very soon.
How Working Capital Is Used in a Business
Working capital is a liquidity (cash)concept. A business might show a "profit," but if it cannot maintain a positive cash position (that is, having money in the bank to pay bills each month), the business cannot continue to operate.
How You Can Get a Working Capital Loan for a Small Business
There are two times when a business needs working capital funds:
At business startup, when bills must be paid but there is little money available because you are just beginning to bring in money from sales. At these times, you may be able to get a temporary working capital line of credit, which allows you to draw on the credit line as necessary to meet cash flow shortages.
At times of change, growth, and expansion, when your business is moving forward and you need cash temporarily to finance that expansion. In these cases, you may want to consider a loan or line of credit from a lender with whom you already do business. For example, PayPal offers a working capital loan for customers with "strong PayPal sales."
Available Programs for Working Capital Loans
The SBA Export Working Capital Loan (EWCL) program is for U.S. small businesses that are able to generate export sales, to help them increase these sales. The SBA says their aim for this program is "to ensure that qualified small business exporters do not lose viable export sales due to a lack of working capital." Here are some details about the EWCL program:
- The SBA provides a 90 percent guarantee on these export loans.
- The loans are for manufacturers, wholesalers, export trading companies and service exporters that have been in existence for one year (although the one-year requirement can be waived if the business can show expertise).
- Collateral for these loans is the inventory and the receivable generated by the sale. The SBA also requires the personal guarantee of owners [20 percent or more ownership).
- The maximum EWCP line of credit/loan amount is $2 million.
The basic SBA 7(a) loan program includes working capital loans.