Working capital is crucial for all businesses irrespective of their size. It’s specifically used to carry out the day-to-day expenses of a business, such as maintaining inventory, fulfilling payroll, meeting outstanding invoices, etc. Not meeting any of these due to a crunch in working capital can throw a wrench into business processes.
Working capital is arrived at by deducting current liabilities from current assets. Therefore, a positive amount would refer to a positive working capital where the short-term account receivables of the company are higher than short-term account payables. A cash-rich state is always the desired state for all small businesses.
However, given a lot of variables such as seasonality of businesses, delays in payments from customers, and unpredictable sales; businesses often run into a negative working capital situation. This leads them to make some hard choices such as downsizing, cutting salaries, selling inventory at a discount, or go into a debt spiral.
Thankfully, this scenario is changing quickly for small businesses as they are now more aware of the many working capital loan options they have should they find themselves in a cash fix.
What is a working capital loan?
Just as the name suggests, working capital loans are designed to help give small business owners the short term liquid boost they need to stay afloat and get back on their feet. These business loans are designed in a variety of ways whereby they provide the latter with the independence to choose their loan plan based on their particular requirements.
The role of fintech in making these working capital loans for SME cannot be overlooked as they have brought in the much-needed features of speed, accuracy, and cost-effectiveness to these loans.
Let’s start with the basic definition of a working capital loan.
Working capital loan for business is aimed to provide small loan amounts that come with short repayment terms. These are particularly designed to help businesses meet their daily liquidity requirements.
What are the best working capital loan options out there?
There are 6 different types of working capital loans that we are going to discuss here today.
1. Short term loans
One of the most popular of all working capital loan options, these loans give business owners access to a lump sum amount for a period of 3 months to 1.5 years. Business owners then return the principal along with the interest at the end of the term. This is what you can say is the simplest loan model that everyone can relate to.
2. Merchant Cash Advances
Merchant cash advances (MCA) come in a close second when it comes to working capital loan options because of their ready accessibility and little to no requirement of credit history. The latest study by National Business Capital & Services estimated this industry to generate an amount of $5-10 billion worth of capital, annually.
The way MCA works is by giving the small business owner a lump sum of cash in advance to help support their working capital requirement. The business then pays back the sum in the form of a pre-determined percentage of their daily credit and debit card sales.
MCA can also be expensive as compared to other small business loan options. Here’s some more information on MCA, whether it suits your business, and what other alternatives you can consider.
3. SBA Loans
SBA loans are the U.S. Small Business Administration-backed loans that offer small businesses capital injections to the tune of $5 million that help them in solving a variety of issues.
4. Working capital LOC
Working capital Line of Credit (LOC) is a unique working capital funding model through which the creditor or funding partner gives the business access to a predetermined amount of funds that the business can use as and when they want.
The best part about LOC is that even though the business has access to the entire amount, they only pay interest on the amount they are using at a given point in time. LOC often works as a contingency fund for businesses who might need cash up front, to pay to their vendors to fulfil inventory or make payments to employees when the business is facing fluctuating sales and not enough revenue.
Also known as invoice financing, factoring is a great way to get rid of account receivables that are yet to be fulfilled for cash, instantly. In this option, business owners can sell unpaid invoices for a fee and get cash in exchange. The fee they pay is for the lender to cover their risk of assuming these account receivables. Factoring helps business owners free up their cash crunch substantially instead of worrying about follow-ups, delays in payments, and a widening gap in their working capital situation.
Here’s an article where you can read up more about invoice financing and if it suits your business’s requirements.
Which one is the perfect working capital loan option for your business?
All these options have plenty of demand in the market. All of them work for certain sections of small businesses. What you need to do is figure out what your particular need is.
• Why do you need the working capital loan?
• How long do you need it for?
• What is causing you to consider the working capital loan?
Here’s a quick checklist of things you should consider to help decide which one is the best working capital loan for you.
1. Calculate your current working capital requirement.
2. Find out the gap (negative working capital) that you need to fulfil.
3. Do some research and find out your business’s current credit standing.
4. Determine which of the above six working capital options work best for you based on the three points stated above.
5. Do some research on the best working capital lenders catering to the option of your choosing.
6. Arrange your documents and fill in your loan application in clear details.
7. Work with the lender through the loan origination stage by allowing easy verifications and document processing.
8. Receive your funds.
9. Use the funds as decided in step number one.
The best way to manage your working capital
Whether you have positive working capital at the moment or are considering a loan, here are some tips to help you stay focused on how to use your working capital more effectively.
1. Monitor every penny spent
Keep a tab of receipts of all expenditures incurred. Small businesses should especially focus on keeping their travel and entertaining expenses to a minimum. Being thrifty as a growing business is the key to handling your finances successfully.
2. Manage your receivables and payables
Try to mail your invoices faster giving customers enough time to fulfil the payment. Give them discounts on making quick payments. Offer the same to your vendors and negotiate discounts on early payments. Also, focus on creating solid relationships with your vendors which can help you secure better deals.
Working capital crunches are something that the majority of businesses go through. But thanks to a booming lender’s market and fintech-powered digital lending platforms, securing quick loans at great payment terms has now become a reality for most small businesses.