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What is a working capital loan?

Written By:
Myles Robinson - Expert Finance Advisor

Posted: Jan 4, 2023

Fact Checked By:
David Nicholson - Finance Editor

What is a working capital loan, and how do they work?

A capital loan is a loan to a business that helps them cover temporary cash flow or working capital that must be repaid.

Working capital is broadly defined as the cash a business has to spend on its daily operations. It is calculated by subtracting current liabilities (such as rent, wages, and payments owed) from current assets for the next twelve months.

Sometimes, businesses might not have enough working capital to cover their day-to-day operations and regular expenses.

A working capital loan is designed to solve this problem by providing short-term financing that will increase businesses’ working capital and enable them to purchase what they need and prevent missing debt payments.

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What can a working capital loan be used for?

A working capital loan can be used by businesses for many purposes.

  • Cover everyday expenses, e.g. rent, bills, or the payroll, are all expenses we have to pay daily.
  • Paying suppliers
  • Equipment purchase
  • Coverage for emergency expenses
  • Stock purchase

The loan is designed to assist businesses and small businesses manage their finances and increase their cash flow.

Remember that working capital loans should not be used for long-term investment in your business. They are intended to meet short-term financial needs.

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How do capital loans work?

You will usually be able to use a working capital loan as much or as little as you want once you have it. As a borrower, you don’t have to limit what you can use the loan for. For example, you could use it as a payment system or to purchase stock.

You will pay the monthly repayments agreed upon with the lender to repay the loan. Working capital loans are relatively short, usually ranging from a few weeks to a few months.

Although many working capital loans can be unsecured, others may require you to make a personal guarantee that you will repay the loan in the event of bankruptcy.

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What are the advantages of a capital loan?

A working capital loan is a fast way to get funds for your business. Some providers and banks will even send funds within 24 hours after approval.

Businesses can increase their cash flow quickly to offset any revenue dips.

Lenders won’t place restrictions on the use of a working capital loan. This allows businesses to be flexible in their spending. Working capital loans can be paid off quickly because they are short-term. You won’t be responsible for the interest rate or the repayment for many years after.

Additionally, working capital loans are usually unsecured so your business’s property won’t be in danger as the company’s assets. You should check with the provider to confirm if the loan requires long term assets or personal guarantees.

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What are the disadvantages of capital loans?

Although working capital loans are a great way to help businesses grow, there are some things you should keep in mind.

The best part about these loans is their ability to provide short-term funding. Working capital loans are available for terms as short as three months. This means that you should be certain that your company will be able to cover the repayment of the loan in full and quickly.

Working capital loans may have higher interest rates. Compare providers to see which deals are available for your company.

Are working capital loans a good idea?

Working capital loans may be worth looking into if your business is experiencing significant revenue fluctuations. If your business is seasonal and has busy months, your working capital may be lower in quieter times. It can be difficult to cover all operating costs and expenses. A loan may help you get by until your sales pick up.

They can help companies manage and stabilize their finances for the short term, as well as help pay expenses such as rent, stock, and bills.

A working capital loan is useful for all businesses, not just seasonal ones that have fluctuating cash flows. If your company has large amounts of stock, it may be necessary to get a short-term loan in order to pay the costs and cover any eventuality.

Any business that has low working capital and needs cash to pay its immediate expenses might consider working capital finance.

You should only borrow money if you have temporary cash flow problems and expect them to improve. If your cash flow drops are more severe, these loans won’t help.

If you need funding for long-term investments, working capital loans may not be the best choice.

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How to obtain a capital loan

Check the eligibility criteria for working capital loans. Lenders may require that you have at least five years of trading experience and a separate bank account.

You can apply online for a working capital loan if your business is eligible.

Lenders will likely want to see details about your trading history, average turnover, the amount of loan you are applying for, and the purpose for which you intend to use the loan.

This information will be used, along with your company’s credit score to decide on your application.

You will usually receive your loan within 24 hours if you are successful.

What other ways can working capital be financed?

You don’t have to use working capital loans to cover short-term cash flow problems. It depends on your business and individual circumstances which type of financing is best for you. You might also consider other options.

Although all of the options listed below can be used to access cash quickly, they each work differently.

Lines of credit – You can access this flexible form of finance whenever you need it. While the lender will give you access to a fixed amount, you have control over how much and when you borrow it. You also pay only interest on the amount you use.

Invoice financing If you urgently need cash, you can immediately release the cash from unpaid invoices. There will be a fee to borrow invoice financing.

An overdraft is a facility your bank account has that you can use to raise funds for your business temporarily. Although this can be a quick way to access funds quickly, check the fees and charges.

Merchant cash advance – This type of financing allows your business to borrow money from a lender. The amount borrowed will depend on how much income you earn each month. Repayments are taken from a portion of every debit or credit payment you receive. This is possible because card providers and lenders work together. Learn more about merchant cash advances here for more information.

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FAQs about Capital Loans

What makes a good working capital?

A wide range of industries and businesses will define what level of working capital is considered “good”. A working capital ratio of 2.0 is considered to be good. Anything below 1 is considered unacceptable.

How do you calculate your working capital ratio?

You can calculate your working capital ratio by dividing your current assets by your business’s liabilities. Your business assets could include cash in your business account, inventory, or other assets easily converted to cash.

Rent, taxes, bills and debts are all examples of liabilities. Divide your assets and liabilities to get a number that will show your working capital ratio. A higher number will indicate that your business is in good financial health and is more profitable.

Are you looking for high or low working capital requirements?

Your business’s working capital could be too low and cause financial difficulties. A high level of working capital indicates that your business is financially sound and has enough cash reserves to expand or invest.

What effect does a working capital loan have on my personal finances?

Working capital loans are tied to your business and shouldn’t have any impact on your personal finances. A personal guarantee from the lender that you will repay the loan is an exception. Learn more about how business loans can affect your personal credit file.

What is the average time it takes to obtain a working capital loan from a business?

The lender will determine this, but most lenders will approve you for a working capital loan within 24 hours of your application being approved. Businesses that need cash flow support will find that working capital finance can be an immediate solution. Some providers offer a 24-hour turnaround.

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To apply for a loan, do I need to have a business account?

It all depends on the lender. However, many lenders will only lend to businesses with separate bank accounts.

What if I have bad credit and want to get working capital finance?

While you may be eligible for a working capital loan even if your credit is poor, other lenders might not approve your application or charge higher interest rates. If your loan is secured by an asset or you offer a personal guarantee, your chances of being accepted may increase.

Can I repay my loan to my business early?

Most providers allow you to repay your loan early but if you select this option, check if there are any additional fees.

What is the best way to get working capital loans for a new business?

Working capital loans are intended to assist existing businesses with cash flow and not to give startups cash injections to start their business.

To qualify for a working capital loan, many lenders require that businesses have a minimum of five years of trading history.

A start-up business loan may be more appropriate if financing for your new business is required.

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