Working Capital Loan for a New Business
As a new business, hitting a financial speed bump can be rather jarring. Without the means to pay for the essentials like payroll and rent, it can be helpful to start thinking about a loan. With working capital loans, you can get the money to take care of your everyday operations without worry. With Backd, you can get a personalized working capital financing plan that suits your business.
Let’s explore the working capital loan definition and how does a working capital loan work?
What Is a Working Capital Loan?
A working capital loan is a short-term, small business financing for your company. Small business working capital loans can help your company cover day-to-day operational expenses until sales, invoices, investments, or other sources allow it to make up the difference. It’s important to note that these funds are not for investing or the purchase of long-term assets. Essentially, alternative financing is for things like payroll, rent, utilities, and any debt payments. The funds could also be used to manage any income gaps during a slow seasonal period.
However, a working capital loan is not for starting a business. They are intended for established companies that want a sum of money in the short term to meet a specific need. If you need money for initial marketing, new workers, or beginning inventory, you’ll need the capital required to start a business.
Are Working Capital Loans a Good Idea?
While there is no catchall answer for everyone, a working capital loan for small businesses typically has a much lower risk than other financing options due to its repayment terms and flexibility. As with most financial decisions for new businesses, it’s important to understand what a working capital loan means for you. Let’s discuss some of the pros and cons of borrowing working capital.
Working capital financing has several advantages that might make it the best solution for your business:
Fast processing: Typically, the borrowing process is drawn out, making it difficult to get the cash you need quickly. With a working capital loan and a good credit score, you’ll often hear back within a few days about the approval. At Backd, we get you an answer within 24 hours of your application, so you have the ability to take control of your finances when it’s crucial.
Short-term lending: While many loan options are available, often they have long terms, which can accrue greater interest and be less advantageous overall. With working capital loans or other business financing, the payment plan is typically between 6 and 12 months.
Flexible spending: There are no requirements or restrictions on what you can spend your loan money on. That means you get to make decisions on what’s best for your business. Payroll, inventory, or any other areas of concern can all be covered with a working capital loan.
No collateral required: Your business doesn’t have to pay any collateral in assets or inventory to get a working capital loan if you have good credit. This means your business is always on its own without any worry about losing your assets.
While working capital loans for startups can keep things running smoothly, there are also some disadvantages to consider:
Repayment of loan: This might seem obvious, but a downside to receiving a loan is paying it back. The important thing to note is that repayment begins immediately and businesses will have to allocate money weekly—or in some cases daily—to repay the loan.
Impacting credit: Because working capital loans impact your credit, you need to be prepared for a credit check, which can impact your credit score. On the other hand, having a lower credit score can impact the ability to get financing. Businesses need to ensure their need for business lending before starting the application process.
Short-term funding: Part of the advantage of working capital loans is short-term lending, but receiving a loan for the short term might make it difficult to pay for expenses after the credit line ends. These loans are used for supplemental financing and are not a main source of financing.
High interest rates: Interest rates on short-term financing are typically higher than funding with longer repayment periods. Because there is no collateral taken, lenders usually lower the risk with higher interest rates.
Working capital loans have their advantages and disadvantages, but only you can determine whether or not a loan would be beneficial to your business. If your business is in a slow period, but otherwise thriving, you have less of a risk than someone whose business struggles month to month to stay afloat. Backd offers you the fastest and easiest way to fund your business, tailored specifically for your business, so you don’t have to worry about taking on more than you can chew. But how will you know the amount of loan you’re eligible for?
How Is a Working Capital Loan Amount Determined?
The right amount for your working capital loan comes from a few factors, namely: the amount of income your business makes and the desired loan amount. You’ll have to disclose why you’re looking for funding, how much you need to continue business without interruption, and how much your business makes. Of course, with business financing, it is always best to request only what you can reasonably pay back within the payment period.
For a working capital loan example, imagine your music store business does incredibly well during the holidays but slows down in the spring. You might need alternative financing to pay employees, maintain inventory, etc. In this season, you typically need $75,000 to maintain your business, but your income has dropped significantly and you only have $50,000 cash on hand or in liquid assets. Your business makes $250,000 a year. So how much working capital does a small business need? Well, in this instance, how to calculate a working capital loan is the amount of working capital you need to maintain your business minus the amount you actually have. In this example, working capital financing of $25,000 would easily help you transition through the down period, without putting you in a bad financial position.
So we know the benefits and drawbacks of working capital loans, but what does working capital actually mean for small business owners?
Why Is Working Capital Necessary for a Business?
Because working capital is based on assets and liabilities—as we’ll explain further in a moment—it can give businesses an advantage by increasing their creditworthiness within the industry. Here are several important reasons why you should be invested in maintaining strong working capital:
Many businesses have seasonal changes in cash flow, which may need additional funding to prepare for a busy season or to keep the business functioning when sales are low.
Shareholders will be pleased with a higher return on investment (ROI) due to higher returns on capital.
Almost every company will require additional working capital while waiting for payments from clients in order to satisfy obligations to suppliers, employees, and the government.
Paying debts regularly and on time will increase the credibility of the business and give them the ability to lower any credit risk.
Having sufficient working capital allows you to take advantage of beneficial business improvements.
Businesses have the ability to cover the cost of temporary employees or other project-related expenses.
How to Define Working Capital?
To understand the necessity of working capital, it’s important to define what it means. Simply put, working capital is the difference between current assets and current liabilities. Working capital helps plan for any financial needs in the future by ensuring there’s enough cash on hand to settle short-term obligations and debt, as well as unpaid taxes. To break it down, here are the different types of assets and liabilities that businesses should calculate for their working capital.
Current assets include:
Current liabilities include:
Debts due within the year
By understanding how the liabilities impact the assets on hand, you can determine your working capital. Here’s an example:
A business owner has started a gravel company, selling gravel to different construction companies in their area. The assets of this business total $500,000, but the liabilities cost them $220,000. In this instance, the working capital would be $280,000. This $280,000 in working capital includes cash on hand, but also the value of equipment, inventory, and even investments.
Typically, you will want your working capital to meet a certain ratio. Based on the assets and liabilities, the general consensus is having a ratio of 1.5 - 2.0. Finding the ratio is dividing the assets by the liabilities, rather than subtracting them. Here’s the formula:
Current assets / Current liabilities = Working capital ratio
This means, in our example, that the gravel company has $500,000 in assets divided by $220,000 in liabilities which leads to a ratio of 2.27:1.
Backd For Business
At Backd, we help you run your business on your terms because you’re the boss. We understand that you know what’s best for your business and want to help you achieve your short-term goals. Because we want you to have the best for your business, we offer no collateral required working capital financing from $10K to $2M from 4-14 months with daily or weekly payments. We have backed over $1 billion worth of working capital lending for over 10,000 businesses. Trust us: we’ve got you covered. Our application is easy, and pre-approval can be completed in as little as a few minutes. Visit our website to apply today!