Celtic Bank Blog

A Beginner's Guide to Working Capital Loans

Have you ever been waiting on a big invoice? Or maybe you received a large order, but needed additional funds to fulfill it. Maybe your business just has seasonal highs and lows. Whatever the case, working capital loans are a quick, accessible solution for the cash flow lows. This is your guide to working capital financing, so you’ll know exactly what working capital loans are and what they can do for your business.

The popularity of working capital loans is rising steadily. In fact, in the past five years the number of businesses utilizing working capital loans has increased by 19%, an increase that has meant over $7 billion in small business funding a year. That’s an average of $89,000 per business. What could you do with $89K in cash right now? Oh, the possibilities... 

 

WORKING CAPITAL BASICS

 

Working capital loans help small business owners with short-term funding needs. Slow seasons. Seasonal rushes. Savings. Emergency funding. You get the picture. We’ll go into all the uses later, but, for now, let’s start with the basics.

Working capital is the money you use for all your day-to-day operations. Start with your liquid assets—cash or other things that can quickly be converted to cash—and subtract any liabilities or obligations you have due within the coming year. This tells you what working capital you have available. Here’s the formula:

Your current assets - Your current liabilities = Your working capital

Working capital is what you have left after you've taken care of your immediate expenses. And it's a key indicator of your business health. You can pay all your bills on time, pay your employees, and meet any other financial obligations you have. But if you don't have any money left over, you don't have the funds you need to grow your business.

So how important is working capital? If you're already meeting all your financial obligations, is it really necessary to have the extra money, or is it just something nice to have?

Working capital is a key indicator of success because healthy businesses have money to keep growing, hiring, expanding, thriving. It's the money you need to do basically anything you want to do. And without it... well, your business may survive, but not without a struggle.

Not all working capital challenges are the same. While some businesses may struggle to have anything left at the end of the day, others just need better access to their money. Working capital loans fill the funding gaps with fast, sustainable, accessible cash. This way, you have the funding to invest in growing your business. OR at least to meet the day-to-day expenses while waiting on customers to pay.

 

PERKS OF CHOOSING A WORKING CAPITAL LOAN

 

There are a lot of financing strategies out there these days, some of which can get you cash within minutes. Why choose a working capital loan?

Working capital loans are fast. Depending on the size of loan, and the lender, you can typically get funds within days. And the application process is usually pretty simple.

Working capital loans may not require collateral. Because working capital loans are primarily here to help with day-to-day expenses, they tend to be smaller than some other types of business loans. The average working capital loans generally fall between $25,000 and $350,000.

Working capital loans are flexible. There are a ton of things that you can do with a working capital loan, like stabilize cash flow, stock up on inventory, hire a new employee, market a new product, take advantage of supplier discounts, or purchase new equipment. 

Working capital loans are diverse. There are many types of working capital assistance. From SBA loans to accounts receivable financing to private party loans, there are a lot of different ways to meet the needs of your growing business. 

 

TYPES OF WORKING CAPITAL LOANS

 

There are a lot of different working capital loans out there—each with its own set of advantages and disadvantages. We’ve put together a list of the most popular. We’ll start with a basic overview of each loan, and then break it down into pros and cons. 

Traditional bank loans

Traditional big bank loans provide affordable, low-interest funding for businesses that qualify. Unfortunately, with rigid qualification standards, getting approved for these loans can be extremely difficult for many small businesses.

Line of credit

A line of credit provides a quick, simple cushion for companies that need a little extra cash. Unlike traditional loans that come in a set lump sum, a line of credit allows you to borrow any amount up to a certain limit whenever you need it, then pay it back with interest later. This makes them great for handling basic working capital needs. Business credit cards and overdraft protection are two examples of commonly used lines of credit for businesses.

Private business loans

Private business loans, like venture debt, are a great option for startup companies and other young businesses. They have a higher risk tolerance than traditional bank loans, but the interest they charge is also pricier—starting between 9% and 13%. Private loans look for a history of rapid, steady sales growth—or potential for buyout from another larger company—rather than years in business, making them an accessible option for younger companies.

Accounts receivable loans

Accounts receivable loans take your invoices as collateral against the loan, advancing you the money that will be coming in. This is more common in business-to-business scenarios, where customers have up to 90 days to pay their invoices. The account receivable loan makes the cash from the invoices available when needed—and not 90 days later. But they also mean that you lose control of certain aspects of your business and can be costly!

Factoring

Similar to accounts receivable loans, factoring allows you to see your accounts receivable invoices for less than they’re worth to get cash now. Again, it’s fast cash, but there are some things to be aware of. Many factoring companies require you to enter into lengthy contracts, which can be frustrating if you only need the loan for a short time. It can also cause confusion for your customers to see invoices coming from another company.

Merchant cash advances

Merchant cash advances offer a quick turnaround loan for businesses who live on credit and debit card sales. You agree to give a percentage of your credit/debit sales as repayment, they give you the loan, and then the lender deducts that percentage of those sales each day, week, or month until the debt and interest have been paid off in full. These are nice for their high approval rates and minimum paperwork. But they are also an unregulated lending industry—which means your lender could charge sky-high interest rates for your loan without government regulation or repercussions.

Short term (alternative) loans

Short term loans are similar to bank loans or SBA loans. They’re based on credit, and may require collateral. However, the funding for these loans is fast. Very fast. Getting you funding within weeks or even days. They can be great for a pinch, because you have access to the money when you need it, instead of going through a lengthy paperwork process. However, these short-term loans can come at a high cost--with interest rates starting at 11% or 12%, and APRs up to 99% once all your other fees are taken into consideration. They also have short repayment terms (one year average, up to three years), which can mean high monthly payments.

SBA loans

SBA loans are offered by lenders and backed by the Small Business Administration. This “backing” lessens the lender’s risk of loss and increases your odds of getting the loan. And SBA loans come with low interest rates—especially compared to some other quick turn-around lending options—meaning that your short-term loan won’t cause long-term financial hardship. If you can get approved, these are arguably one of the best working capital loan options (though we do claim a little bias here). 

 

  Pros Cons
Traditional bank loans
  • Lowest interest rates
  • Reliable
  • Very high qualification standards
  • Low approval rates
Line of credit
  • Instant money when you need it
  • No additional paperwork
  • No outside lenders
  • Low caps on loans—not good for large funding needs
  • Lots of extra fees
  • Not a long-term solution
  • Limited amount of times to use this service
Private business loans
  • Available to young companies and startups
  • Works for companies that may not make a profit for the first few years
  • Higher risk tolerance, so better approval rates
  • Getting investor funding is highly competitive
  • Slow process finding the right investor
  • The interest charged can be pricey
Accounts receivable loans
  • Fast cash
  • No collateral required
  • Lose control of certain business processes
  • Cost: Not only will you be paying a percentage of your invoice for the loan, but there will be interest taken as well. 
Factoring
  • Fast cash
  • No collateral required
  • Don't have to worry about collecting on invoices
  • Lose control of certain business processes
  • Some factoring companies require a lengthy contract, which can be against your favor if you only need the loan short-term
  • It can be confusing and concerning for your customers when they start getting invoices from another company instead of you
Merchant cash advances 
  • Fast cash
  • Minimal paperwork
  • No fixed monthly payment
  • High approval rates
  • No collateral required
  • Automated payment, which means you'll never overlook a due date and incur a late fee
  • Small loans available
  • Unregulated lending industry, so you need to make sure you do your homework and know your lender beforehand
  • Can put limitations on your business—like penalties for encouraging customers to pay with cash or prohibiting switching credit card processing companies
  • No fixed repayment term, which means if sales go down, it may take you longer to repay the loan
  • Your lender has first access to the money, so you may not have enough left after paying the debt to meet other payment responsibilities
Short term (alternative) loans
  • Fast cash
  • No lengthy contract
  • High approval rate
  • High interest rates
  • High monthly payments
  • Short repayment terms
  • May require collateral 
SBA loans
  • Low interest rate
  • High approval rate
  • Flexible uses
  • Higher lending cap
  • Some paperwork required
  • Not instant
  • Collateral may be required depending on the loan size

 

Now that you know the facts—the pros and the cons—of each loan type, let’s talk about application. When it gets down to it, what does all of this look like on paper? Can you really see a difference in these options?

To illustrate, let’s take a look at an example that shows the difference the type of financing makes:

Jared owns an assisted living location. Recently, he added a special alzheimers-dementia care facility. Jared took out a $100K loan to launch a marketing campaign announcing its completion. He wanted to get the news out quickly, so he went with a fast-funding alternative loan he found online. But the fast funding had fast repayment terms, too. One year to repay, which—once he included the interest rates—meant $8,890 a month just to keep on top of payments. It seemed like the money he got from the loan was just going right back into repaying the loan, instead of toward the marketing to grow his business.

As things got harder, Jared decided to talk to a bank and see what could be done. The loan officer suggested getting a small SBA working capital loan to pay off the quick loan. With the SBA loan, his interest rates went from 29.4% to 6.35%, and he now has ten years to pay off the loan. This took his monthly payment from $9,000 to just under $1,130. And Jared now truly had the cash to advertise and start generating business for his new facility. 

 

APPLYING FOR A WORKING CAPITAL LOAN

 

Alright. The big step. You’re ready to apply. Wondering what to expect?

The application process for working capital loans will vary from lender to lender, but chances are it’s easier than you think. Depending on your lender, you can expect it to go something like this:

  1. Apply online—many applications can be done in less than 30 minutes.
  2. Get pre-approved within 48 hours—often, within minutes!
  3. Submit additional paperwork for approval and verification.
  4. Get funding within days of approval.

Easy-peasy, right? Because it needs to be fast!

A lot of working capital loans are used to solve immediate and pressing problems. Emergencies. Last minute cash flow issues. Limited-time buying opportunities. It’s a short loan process for a short-term loan.

 

 

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