What Is a Working Capital Loan?
There are many funding options when a business is having an off month, with a large percentage of business owners relying on what’s referred to as a working capital loan. But what is a working capital loan? First, we must define “working capital.” Loan lingo can get a bit tricky, but it essentially boils down to this:
- Working capital refers to an accounting equation that calculates your current assets minus your current liabilities.
- Current assets are liquid assets that can be converted to cash within one year.
- Current liabilities are any financial obligations that are due within one year.
A company’s overall financial health is reflected in its working capital. Loan debts and other types of debts are taken out of all of the company’s assets, and the margin you have left over is like a litmus test of how your company is doing. A positive number is important for the company to keep going and growing. If your working capital is negative, it’s a bad sign; it means that you may not be able to cover your current liabilities.
Working capital is used to meet operational needs, such as for payroll, paying bills, or other overhead costs. So what is a working capital loan?
- A working capital loan is a loan acquired to cover operational expenses in the short term. They’re meant to be used to cover accounts payable, payroll, and other short-term needs.
If your working capital is low (if your assets are worth less than your current liability), choosing to cover costs with this type of loan can help fill sudden gaps in cash flow or help you deal with the inevitable seasonality of certain industries. They give businesses the flexibility to adjust and adapt as business ebbs and flows. They’re not meant for long-term solutions or major purchases but rather to cover operational costs. Often, a working capital loan helps a business get back to a comfortable place where the current assets are either equal to or more than current liabilities.
Is a working capital loan a good option for your business to rely on? It greatly depends on what your needs are. Sometimes, a company might have several high-value assets that don’t have enough liquidity (the ability to be turned into cash or sold). Sometimes, the off- and on-seasons a business goes through are incredibly different; such is the case in many manufacturing industries.
Also, the choice of whether or not to get a working capital loan will depend on the type of loan involved. You could turn to a short-term business loan, invoice factoring, or another financial solution. Merchant cash advances from a qualified lender like BFS Capital are a fast way for several types of small businesses and vendors to pay operational costs, for instance, and applying isn’t as much of a hassle as with larger loans. In retail, certain short-term loans will be used to stock up before the holiday season. Many factors, including credit, determine whether you’ll qualify for or prefer one type of working capital funding over another.
Understanding what a working capital loan is will help you best assess your funding options and get the funds your business needs. Use this information to make educated decisions about business funding. Then, apply for BFS Capital’s loans for small businesses!