What Is A Working Capital Loan?
- Written by The Times
A working capital loan is a type of short-term loan designed to provide a business with the necessary funds to cover its day-to-day operational expenses. Such expenses can include anything from rent and payroll, to inventory and equipment costs.
Unlike other types of loans – such as equipment loans or commercial property loans – a working capital loan does not have a specific purpose. It is more generic in nature and can be used for any running costs the business needs to cover.
How Does a Working Capital Loan Work?
A working capital loan is typically offered by banks, credit unions, and other financial institutions.
The loan amount and terms will vary depending on both the lender and the financial needs of the business, but generally, working capital loans are short-term loans. The loan amount can differ enormously, but will usually range from $5,000 to $1,000,000.
The loan will usually have a fixed interest rate with monthly or bi-weekly payment terms.
There are generally 2 options when it comes to taking out a working capital loan:
Secured loan: A secured loan is when a business is required to provide collateral (i.e. business or personal assets) to secure the loan. This means that if the business is unable to repay the loan, the lender can seize the collateral to recoup their losses. This can be risky for businesses, as they may be forced to release assets that are essential to their operation.
Unsecured loan: this is where nothing is required as collateral against the loan. This can be beneficial for businesses that may not have assets to use as collateral, or do not want to risk losing their assets in case of default.
To attain an unsecured loan, a business needs to have an excellent credit rating, as the lender is taking on all the risk. As a result, unsecured loans tend to have a higher interest rate.
From small business start-ups and SMEs, to large corporates, loans for working capital can prove a viable solution for all manner of situations.
What Are the Benefits of a Working Capital Loan?
There are several advantages to obtaining a working capital loan for your business, including:
Improved cash flow: A working capital loan can help improve your business’ cash flow, with immediate effect. This can enable you to take advantage of new business opportunities, or invest in new equipment or technology that can help grow your revenue.
Flexibility: Unlike other types of loans which have specific purposes, a working capital loan can be used to cover any operational expenses. This gives you more flexibility in terms of how you use the loan funds.
Fast approval: As loans for working capital are designed to provide businesses with funds quickly, the approval process is typically faster than for other types of loans. This allows you to secure the funds sooner, which can be critical for businesses with cash flow issues.
Short-term commitment: Working capital loans are generally short-term loans with a repayment period ranging from 3 months to 2 years. This means that you won't be committed to the loan for an extended period of time.
What Are the Disadvantages of a Working Capital Loan?
While there are several benefits to obtaining a working capital loan, there are also some potential drawbacks that you should be aware of before applying for a loan.
High interest rates: The interest on working capital loans is typically higher than that for other loan types. This is due to the short-term nature and the higher risk associated with lending – and can result in a significant increase in the overall cost of borrowing.
Short repayment terms: Working capital loans are usually short-term loans which must be repaid within a year or under. While this can be beneficial in that you’re not locked-in for an extended period, it can put a strain on a business' cash flow, as you will need to make regular loan payments while still covering your daily running costs.
Strict eligibility criteria: Lenders may have strict eligibility criteria that a business must meet to qualify for working capital finance. This can include minimum revenue requirements, credit score thresholds, and other financial metrics. It may therefore be difficult for some businesses to access the financing they need.
What Businesses Can Apply for a Working Capital Loan?
To apply for a working capital loan, you must have a business that is registered in Australia and you’ll be required to supply your ABN or ACN.
From professional service and childcare providers, to home improvement and retail businesses, right through to freight forwarding operators and more – any business can apply for a working capital loan, no matter the industry.
However, the success of your application will, of course, depend on your current situation, loan serviceability and financial history, as well as the lender’s prerequisites.
How to Get a Working Capital Loan
The application process for a business working capital loan is relatively straightforward, and the approval process is typically faster than for other types of loans.
To apply for a working capital loan, you’ll need to provide the lender with information about your business’ financial history, such as tax returns and bank statements, as well as personal identification documents for the applicant.
A professional business finance broker can help you navigate the complexities and secure a competitive loan which is tailored to your specific requirements.
Here are the 6 key steps involved in applying for a working capital loan:
Establish your needs: Before starting the application process, it’s important to establish exactly how much money you need to borrow and for what purpose.
Choose a lender: Research different lenders and compare their interest rates, fees, and eligibility requirements.
Gather your documentation: Lenders will require you to provide financial information and proof of identify documentation.
Complete the loan application: Be sure to provide accurate and up-to-date information, as any errors or omissions can delay the approval process.
Sign loan documents: Once a lender approves your loan application, they will provide you with loan documents to review and sign. Read the loan agreement carefully and make sure you understand the terms and conditions before signing.
Receive loan funds: After you sign the loan documents, the lender will deposit the loan funds into your business’ bank account.
Is a Working Capital Loan Right for You?
Overall, a working capital loan can prove a valuable source of financing for businesses that need to cover their operational expenses. However, it's imperative that you carefully evaluate the pros and cons and explore alternative financing options before making a decision.
