Working capital loans are types of short-term loans that alternative lenders or banks provide to finance the daily operations of a company. The primary objective of a working capital loan is to offer working capital for short-term capital expenditures like rent, wages, debt service payments, or for financing activities like research and development or marketing and sales.

Working Capital Defined

For you to understand how working capital loans work, first, you should understand what a working capital is. At its very core, you can consider working capital as money on hand. When the assets of the organization offset its liabilities, the organization got working capital.

However, mobilizing working capital could be more complicated than just having assets on hand because of some of the assets’ relative illiquidity like land or intangible assets like intellectual property.

How to Use Working Capital Loans

Working capital loans seek to supplement the temporary shortfalls in the working capital with the use of outside funding. You can use a working capital loan for different purposes such as the organization’s tactical positioning.

For instance, a shark spike in demand for a product of the company because of unforeseen circumstances might present the organization a unique opportunity. In the event that the company doesn’t have enough on hand working capital and their product’s demand clearly outstrips the present production, it might search for funding to buy more raw materials to increase the inventory.

A working capital loan may also be similarly sought by business owners to make the most out of the discounts on bigger purchases that a supplier offers. This kind of investment in one resource that an organization needs might prove to be crucial to the business’s health as well as its profit margins.

It is important to note that in general, a working capital loan is not used for investments and long term assets since there are some types of financing that provide better interest rates for this form of investment.

You can choose between unsecured or secured working capital loans although many are backed by collateral or are secured. To get unsecured working capital loans, the organization needs a high credit rating to guarantee some insurance for the lender that they are going to be repaid.

Advantages:

• A working capital loan is generally easy and fast to secure to allow business owners for efficient catering to immediate financial needs.
• These loans are received in a single lump sum all at once to increase the effect of the funding.
• Lending institutions could match the payments for working capital loans to the business cash flow to prevent adding more burdens on the part of the business in times of low activity periods.
• It is not required for business owners to give up control and equity in their organization.

Disadvantages of Working Capital Loans

• For small businesses without cash flow track record, working capital loans good be tied to the personal credit of the business owner and any default or missed payment can hurt the credit score of a person.
• Interest rates relatively higher than other types of debt financing as compensation for the higher risk of the lender.