You may have heard the saying: turnover is vanity, profit is sanity, cash is king. And while there are many more sayings and mantras related to the art of business, that one in particular will always ring true.
To achieve even a sliver of success in the world of business, you need cash at the ready. Otherwise it becomes nearly impossible to cover the daily costs associated with growth. Even the best business ideas have been stopped in their tracks due to a poor cash flow.
Avoiding such a scenario requires access to working capital, and in this post we’ll briefly discuss what that is, what we mean by a ‘working capital loan’, and some of the advantages and disadvantages of working capital loans.
What do we mean by ‘Working Capital’?
Put simply, working capital is the money that’s immediately available to fund the short-term needs of your business.
As your company grows, you’ll notice that more and more cash is tied up in the day-to-day running of the business. Where accounting is concerned, we observe working capital as current assets minus current liabilities, but for everyone else, working capital is simply what you’re owed plus what you own, minus what you owe your employees and suppliers.
Working capital also includes the cash you have stored away in your business bank account. And one of the major challenges small businesses face is not having enough of it.
This can be quite jarring to entrepreneurs who’ve had early success where finance is concerned. To go from having a funded and thriving business to one that’s scraping the barrel in pursuit of growth can be stressful.
Often, this can result in desperate business owners plowing their own money into the business just to keep it afloat. But that’s never a good idea; particularly when there’s a better and more secure option in taking out a working capital loan.
What is a Working Capital Loan?
A working capital loan is a very specific type of business loan with the sole purpose of helping a business meet its everyday financial needs.
In contrast to traditional business loans, you’re typically not obliged to submit the loan’s purpose to the lender when you apply for a working capital loan. It’s expected that the money will be used to fund a cash shortfall and keep your business going. To that end, you cannot use working capital loans to purchase assets or for investment purposes.
5 advantages of Working Capital Loans
1. Always Ready
Even the best run, most successful businesses can very quickly unravel if they don’t have immediate access to working capital. Using a working capital loan allows you to be proactive in the face of financial uncertainty, keeping your business on track and in the black.
2. Few Restrictions
Unlike other types of business loans, there are very few restrictions attached to working capital loans. You are simply expected to use the money to fulfil short-term financial obligations, or explore short-term business opportunities (such as buying stock ahead of a busy seasonal sales period).
3. Maintain Ownership
Sometimes, when businesses run into financial trouble, they’ll turn to private investors to dig them out of a hole. But this comes with the caveat that equity is given up in return for funding. This dilutes the owner’s say in how the business should be run, and leaves their position under threat to outside influences.
By borrowing working capital from a bank, you’ll avoid such a scenario provided you make the payments on time, therefore maintaining ownership in the long-run.
4. Shorter Terms
When faced with a short-term financial problem, the last thing you need is to be burdened with years of repayments plus interest when trying to solve it. Working capital loans are ideal as they’re specifically designed to deal with short-term scenarios.
5. They’re Fast
Which is a good thing, because if you had to jump through the same hoops associated with your typical business loan, your business could be dead and buried by the time you’re approved. Provided you qualify, and can prove you can fulfil the repayment schedule, you can generally expect to have access to the money you need within a week of your application being accepted.
And some disadvantages of Working Capital Loans
Working capital loans aren’t all sunshine and rainbows. There are unfortunately some drawbacks, including the fact that you will need to factor in repayment when you borrow the money. Even if your business subsequently fails, you’ll still need to pay back the loan.
You’ll also run into higher interest rates if you take out an unsecured loan, as they’re more risky for lenders. That’s why they’re also more difficult to qualify for. If you go down the secured loan route, you’ll need to put up collateral.
And you can only really use working capital loans sparingly. If you continue to fall back on them as a short-term funding solution, you’ll risk significantly damaging your credit rating.
Need some help? Let’s get started
Knowing when to apply for a working capital loan can be tricky, particularly when you’re not accurately forecasting cash flow. By implementing modern cloud accounting software, we can help you avoid that sinking feeling of not knowing how to meet your next payroll.
To find out more, speak with one of our dedicated business advisers. Contact us today.