One of the trickiest and most complicated parts of setting up a business is funding it. An established small business, developing and managing it needs a decent amount of working capital. To get the funding, most business owners opt for different kinds of finance for small businesses. However, finding the correct funding is also a challenging task, as there are a plethora of options out there. One such beneficial funding type is a working capital loan.
So, what is working capital finance? What are its types, features, and benefits? How to apply for it? To get answers to all your questions, you need to read this article from top to bottom. It is so because here in this article, we will discuss everything that you must know about working capital finance for small businesses.
The definition of a working capital loan
You can consider working capital loans like bridging finance or other funding types. A working capital loan is funding businesses can use for short-term financial needs and day-to-day business operations. Besides, you can also use the fund for various purposes like inventory management, payment of employees’ wages, buying new equipment or materials, and many more.
The types of working capital loan
There are three types of working capital loans out there. They are as follows.
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Short-Term Loans
It is the first type of working capital finance. It generally comes with a fixed term ranging between 1 to 12 months. It also carries a fixed interest rate. A borrower with a satisfactory credit score can take out this loan with less documentation and verification and with or without security. Due to this, this funding type is suitable for companies that need capital on an urgent basis.
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Bank Overdraft
Banks offer this kind of working capital loan to business clients. Whenever there are insufficient funds in the borrower’s account, the bank provides an overdraft to meet the demand for cash flow.
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Line of Credit Loans
The third type of working capital loan are line of credits. It is a popular funding type among borrowers as they provide a limit of funding that can be drawn and repaid as often as you like provided you stay within the limit. Besides, this type of funding you are only charged interest on the amount that you have drawn.
The features of working capital loans
As you know, there are different kinds of loans out there. But not all have the same features. For example, if you choose between a working capital loan and a first mortgage loan, you will find some unique features. Getting knowledgeable about those features is crucial to determine whether the funding type is suitable for you or not. That is why, to help you with this, we have listed below some key features of a working capital loan.
- The loan amount offered through the working capital finance depends on your business type, experience, and term requirements. Due to this, it differs from lender to lender, and you can customise the loans to suit your financial requirements.
- Another feature of this loan type is the difference in interest rates. The interest rate will vary depending on the amount and the term required.
- The third feature of a working capital loan is the same as the first mortgage loan and other funding types. You can take out a working capital loan secured by your real estate assets. Secured loans are generally at a better interest rate and no financial documents are required On the contrary, if you take out an unsecured working capital loan, the lender will look at your financial statements, profit and loss report, tax returns, and credit score to determine your eligibility.
- Like bridging finance, working capital loans come with a processing charge. The fee charged for this funding varies between lenders.
- Working capital loans can be used for any business purpose.
Pros of working capital loans
- The most outstanding benefit of a working capital loan is unlike a first mortgage loan. You can get access to this kind of financing hassle-free.
- You can use the funding to cover any gaps in your working capital expenditures.
- Another advantage is that a working capital loan can be approved and funded in as little as 24 hours.
Cons of working capital loans
If you take out a secured or collateral working capital loan, you have to put your asset at risk. It is a drawback as you might lose that asset if you fail to repay the loan on time. However this is worse case scenario.
Unlike bridging finance and other loan types, a working capital loan comes with a higher interest rate.
This type of finance is often tied to a borrower’s personal credit. As a result, any missed payments or defaults might hurt your credit score negatively.
Bottom Line
So, working capital finance for small businesses is a beneficial and productive funding type for small and large-scale companies. But before applying for it, you must know its pros and cons to determine whether it suits your business demands or not. After all, you will want money to operate and fulfil your business purposes. As a result, you must select a loan to achieve your dreams.