Advantages and Disadvantages of Working Capital Loans

First Financial Franchise Purchase, SBA Loan, Starting a Business, Working Capital 0 Comments

Securing a loan for working capital is an excellent way to begin generating both capital and growth from your business. To get your business off the ground, capital is essential for covering the financial needs of your daily operations such as payroll or marketing costs. Funds that are available to cover your business’s short term and immediate needs are known as working capital. This capital can be redeemable notes or cash at the bank. Often times, small businesses such as yours may struggle to come up with enough working capital to keep their business running. Even if you’ve managed to secure the necessary startup money and establish a customer base, working capital will be necessary to keep things moving; but it can be difficult to access. Mistakenly, business owners tend to try filling the gap using their personal funds. While it may seem like a viable option, it can quickly become a slippery slope. Instead, securing a loan for your working capital will ensure that you get the cash your business needs without jeopardizing your personal finances. As previously mentioned, a working capital loan is designed to finance your business’s daily expenses (think payroll, supplies, etc.). Working capital loans are not intended for investments or the purchasing of assets.

Regardless of the status of its profit and loss, a growing company is going to require cash to continue functioning. This consumption of cash is referred to as working capital.
To put it into mathematical terms, working capital is the difference of your current assets and liabilities. In layman’s terms, it’s what is owed to you by customers plus your established inventory minus your debts to vendors and employees. Your cash in the bank also factors in.
Working capital loans are specially designed to meet your business’s daily operating needs. Different from conventional commercial loans which are approved only for specific uses, working capital loans may be granted without specification of its purpose. The loan will be approved regardless of its use within your business. Remember that working capital loans are a short term option and are not intended for funding the purchase of assets or refinancing current long term debts.

How should a Working Capital Loan be used?

The limits to how a working capital loan can be spent are few: buying assets and funding your business long term. True to its name, the loan can be used for anything that promotes the growth of your working capital. That may look different depending on your business and your situation. The manner in which you spend the loan should be based on the needs of your business.

For example, if you need to plan on covering daily expenses during those typically slow months the loan can help you meet those financial obligations. Or, if an upcoming holiday demands that your inventory be expanded the loan can bridge the gaps in your current funds. Additionally, should you need to take a vendor up on any one time offer discounts, the loan can be used to ensure that opportunity doesn’t pass you by due to a lack of funds. Short term loans such as this are also very helpful in covering any unexpected losses that may come up. Numerous expenses can lead to a gap in your cash flow. Maybe you’ve recently put extra money towards advertising and marketing, hired new employees, or relocated your business. Perhaps it’s simply time to update, renovate or expand your business and inventory. The economy may have caused an uptick in customers who are slow or unable to pay. Maybe you’ve experienced some operating losses which depleted your funds. The point is, many situations may arise that can leave you temporarily unable to meet the financial demands of your growing business; that’s where a working capital loan comes in.

Working Capital Loan Benefits

You are insured against any financial constraints that might arise. Even businesses worth billions may find themselves in court if the monthly bills aren’t paid. Even in the best cases, depleted working capital can result in financial pressure, an increased need to borrow, and payments made past due. These things will negatively impact the business’s credit score which will in turn result in higher interest rates on any future loans. Taking advantage of a short term loan for working capital when necessary will ensure that you stay in business even when losses occur.

Working Capital Loans ensure that you remain the sole owner of your business

To cover the financial deficits, you may experience, you could turn to an investor. But, it’s likely that in exchange for those funds you will lose ownership over a percentage of your business. Along with the loss of ownership you will be relinquishing much of your ability to make decisions for your business. However, if you turn to a financial institution such as a bank to fill your financial needs, you’re only obligation will be to make your payments on time. Securing funding through a bank guarantees that you retain full control over your business.

You won’t need collateral

Generally speaking, loans are either secured or unsecured. Though mostly unsecured, working capital loans do come in both forms. Unsecured loans are reserved only for small businesses with excellent credit history and zero (or very small) risk of defaulting. For business owners lucky enough to fall into this category, a loan can be secured without the use of your inventory, business or personal property as collateral. Obviously, under these circumstances repaying the loan diligently is crucial if you don’t want legal action brought against you.

Temporary loans for temporary problems

With a short term loan, you won’t be committing yourself, or your business, to years of interest and payments. Working capital loans are specifically intended to serve as a quick infusion of cash, which is in turn quickly repaid.

The money can be spent at your discretion

Typically, the restrictions imposed on your loan will be few to none. Your lender will only expect that you spend the money maintaining daily operations or increasing revenue, which shouldn’t be a problem because a business owner such as you intend to do those things anyway!

It’s Fast!

Conventional loan application is a lengthy process, and you’re approval is not guaranteed. You may fill out excessive paperwork, establish collateral, personally guarantee the loan, establish a payment schedule and agree to the terms and restrictions only to find that you’ve been denied (and that you’ve wasted too much of your time). Working capital loans are simpler to apply for, quicker to pay out and easier to use because of the lack of restrictions on how you can spend it. With a working capital loan, you can access the money within as little as a week following the acceptance of your application.

Working Capital Loan Drawbacks

It will need to be repaid

As with any borrowed income, your debt will need to be repaid. Just like any loan, you have an obligation to make payments in a timely matter, regardless of what becomes of your business. That means that should your business fail, repayments on the loan will need to continue anyway. If the worst happens and you are reduced to bankruptcy, you’ll need to prioritize repaying the lenders over any investors to which you are obligated.

Collateral may be required (especially for candidates with a lesser credit history)

While it’s true that borrowers with a sterling credit history may be approved for an unsecured loan with no collateral required, that will not be the case for all borrowers. Lenders will need some form of assurance that the debts will be repaid. If assurance can’t be established by your credit history alone, collateral may be required. This means you’ll be applying for a secured loan (one in which collateral is exchanged for funds), and will need to offer a tangible guarantee that the loan will be paid on time and in full. The guarantee can come in the form of a home, vehicle, inventory, even jewelry. Assets can be exchanged as collateral regardless of any mortgages you may still owe on them. While the collateral required for a working capital loan will vary by lender, you can get an idea of what you’ll need by examining your credit history and looking into typical small business loan requirements.

High interest rates

Understand that an unsecured loan presents some risk for lenders. Typically to temper the risk that risk, they’ll charge a higher percentage of interest on the loan. This means that compared to a secured loan for the same amount, you’ll end up paying more long term. A higher rate will also bump up the monthly payments you make; depending on the bump, this can make the payments more difficult to afford. Finally, it’s harder to be approved for an unsecured loan. Lenders probably won’t approve a business with a credit history that’s poor or not well established.


PUT YOUR BUSINESS ON THE FAST TRACK

SBA Express Loan

No Collateral Small Business Loan, up to 150K and great rates.

SBA SLA2 
(Small Loan Advantage)
$150K – $350K

FOR: Start-Ups, Existing Businesses, Working Capital, Equipment, Build-Out and all soft costs

SBA 7A Loans $350K up to $5 Million

FOR: Start-Ups, Business Acquisitions, Debt Refinance, Working Capital, Inventory and Tenant Improvements


Negative effects on your credit

Be aware that each time you do take out a loan it is noted on your credit history. While a few loans, repaid on time, can help your score and boost your business, too many loans will flag you as a high risk borrower. The higher your risk as a borrower, the more interest you’ll have to pay. Obviously, late payments or failure to make payments at all will directly and negatively impact your credit. Be sure to borrow within your means and within reason.

Brief terms

That’s right, this is listed under both columns because depending on your needs a short loan term may help or hurt you. For one, a short term loan is meant to solve short term problems. This is not the loan to take out to reach your long-term goals or complete large scale projects with.

Explore Your Business’s Potential

Working capital loans are a great option if you’re looking to test the potential of your small business. Provided you’re on good financial footing, a short term loan can provide the extra little push you need to see your business explode. A working capital loan can beef up your inventory, hire that extra pair of hands or just cover those slow months that you need to get through. Whatever your need, consider how a working capital loan might help. Expand your business without relinquishing control to an investor. Repayments can be easy and most of all, short term loans (when borrowed responsibly) can shore up your credit as well as your reputation. When the time has come to expand your business, apply for a working capital loan.

Give First Financial a call for your next business loan. We offer working capital loans through the SBA with great terms and rates. . With a working capital loan from First Financial, you won’t miss that sale on inventory, you can increase efficiency by purchasing necessary equipment or you can hire needed help for your busy season. For your working capital needs, First Financial is a great solution.

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