Working capital measures how much cash your business has on hand to cover daily operating expenses, like payroll, utility payments, supplier invoices, and more. It’s one of the major indicators of the financial health of your business, and you can calculate it by subtracting your liabilities from your assets.
A positive cash flow indicates that your company is in good financial health. You’ll also know if your business is profitable if you have a positive balance after subtracting all the liabilities. On the other hand, a negative working capital indicates that a part of your business processes isn’t working efficiently, like late-paying customers or slow sales.
When this happens, small business owners often turn to lenders that offer working capital loans to improve their cash flow. While these loans can be beneficial, it’s important to weigh your options before borrowing money.
In this article, we’ll dig deeper into the pros and cons of working capital loans.
The Pros of Working Capital Loans
- You remain in charge of the business.
Getting a loan from a bank or an online lender allows you to remain in charge of your business instead of working with investors. You don’t have to give up equity or ownership or have someone else run the business for you. A working capital loan is similar to any other business loan: you apply for a loan, get approved, receive the funds, and continue growing your company.
- You won’t get tied up with a loan for the long term.
Working capital loans are often structured as short-term loans. This means that you won’t spend five to seven years paying off a loan. You can easily repay the loan, so you don’t have to set aside money in the future.
- You can enjoy the flexible use of funds.
Unlike some loans that come with stipulations on using the funds, the money from working capital loans can be used for almost any business purpose. You can use it for inventory purchases, payroll, or day-to-day expenses.
- Quick application process
The underwriting and application process for working capital loans is generally quicker than traditional loans, especially through alternative lenders. All you have to do is submit an online application, choose a loan type, apply and compare loan offers, and get funded within 24 to 48 hours. This makes working capital loans a great option for companies needing a quick injection of cash.
The Cons of Working Capital Loans
- You need to repay the loan.
This point may seem like a no-brainer, but many business owners fail to realize that they need to allocate money every month, week, or year to repay the loan. Even if the loan didn’t meet your needs or you realize that you don’t need the loan in the first place, you still need to repay the total amount, plus interest. To do that you need to be financially stable.
- You may need to pledge your assets.
While most lenders don’t require collateral, some may ask for security, especially if the borrower has bad credit history. When using your assets as collateral, there’s always a risk of repossession if you default on the loan.
- Some lenders charge high interest rates.
If lenders don’t ask for collateral, they usually offset the risk they take by charging high-interest rates. However, this depends on the lender you’re working with. It’s important to know your options and compare the terms of the loan before making a decision.
What’s Next? How to Use Working Capital Loans
Working capital loans are ideal for short-term funding needs since it has a quick turnaround time and you can use it for a variety of purposes. For instance, an increase in demand for your products or services presents a great opportunity for you. But if the demand outweighs your capital, the business owner may seek funding to purchase raw materials for catering to the increased demand. Business owners can also use a working capital loan to take advantage of large discounts offered by suppliers. It’s important to note that working capital loans are generally used for short-term expenses, rather than for long-term investments.