Working capital consistently ranks among the top financing needs for small business owners but what it is, or what it can be used for still remains a mystery to many. Under its most basic definition, it is cash-on-hand to fund the continued operation of your business. Not all business owners need to take a loan out or open up a line of credit to access working capital. Those business owners who have positive monthly cash-flow each month are often able to accumulate enough money in the bank for regular operating needs. However, many businesses regularly feel the pressure of paying bills, meeting payroll, buying equipment or inventory or having extra cash to take advantage of business opportunities. Since the lenders that fund working capital allow it to be used for most business purposes, there are few restrictions on what you can do with it to help your business thrive. For this reason, borrowers often opt to borrow working capital versus a specific collateral driven business loan, because the loan process will be simpler and the lender won’t usually lien any hard assets.
Working Capital for New Businesses
Most businesses could benefit from having extra working capital on-hand, even the strongest business with cash on its books could always use access to more for unexpected events. For businesses that are in the start-up phase, are less than one year old or aren’t profitable yet, having access to working capital is all about growth and sometimes even survival. Operating your business in its first year can be troublesome, gaining access to a credit card might not be possible, and the personal funds you have to contribute may be limited. In these circumstances, locating a lender that will evaluate the monthly revenue coming into your business bank account is required. Many lenders will want to look at your business tax returns (which you may not have yet), or your profit and loss statement (which may show a loss). The trick is to avoid prohibitively expensive financing such as merchant cash advances, that can put you out of business before you even have a chance to get going.
Our recommended working capital loan lender Credibly, can provide affordable cash-flow based financing for businesses in operation less than one year. The right lender will also not lend you more than your business can afford to pay back. It’s important not to be lured in by large advance sizes and costly loan offers, start with a small amount of financing that will get you to the next step. Credibly will help you grow your business over time by offering your right-sized financing that is tailored to your business.
Rainy Day Working Capital
There may be business owners reading this article who are fortunate enough to have saved up sizable cash reserves and can easily fund their continued operations without borrowing; this is fantastic and the dream of any small business owner. Although, as we learned from the Great Recession, business profitability and revenue can turn on a dime, and it’s important to have access to capital (other than your well earned cash reserves) in the event of an emergency. Depleting your cash reserves for an emergency event, or even to capitalize on an advantageous business opportunity can be a concerning prospect. It’s always best to keep your liquidity available and put affordable back-up financing in place in case you need it.
Our recommended credit line lender OnDeck, can approve your business for a working capital credit line (if eligible) up to $100,000. There is no cost to apply, no paperwork, and no obligation to proceed or draw down from your credit line if you are approved. Applying with OnDeck is free and doesn’t affect your credit, there is no risk to seeing if your business can be approved and putting backup financing in place right now.
Working Capital for Large Expenditures
Sometimes a business opportunity will arise that requires a large amount of capital. In these cases, it is often difficult to borrow enough from an alternative working capital lender or line of credit provider. The ratio alternative working capital lenders use to determine the amount of financing they will provide is usually around one to three times your average monthly deposit balance (this will vary lender to lender). This means that if your average monthly balance in your business bank account is $5,000, you could borrower up to $15,000 from an alternative business lender. These lenders base their loans on monthly cash-flow so they usually don’t give much weight to annual revenue or net income present on your tax returns.
A full documentation lender that evaluates tax return income usually can get to a much higher loan amount and will be the best option for large working capital needs. In the same example above, if you have a $5,000 average monthly balance this will likely equate to an annual net-income on your tax returns of around $60,000 ($5,000 x 12 months). A tax return lender will take your net-income and apply a debt-service coverage ratio of usually around 1.25 times. This means that your annual net-income must be at least 1.25 times the annual debt payments you can afford. In this scenario, the lender would determine that your business could afford annual debt payments of $48,000 for your loan ($60,000 / 1.25). Taking an 8.25% interest rate that is amortized over 10 years (the current usual terms on an SBA working capital loan), you could expect to receive a loan amount of $325,000!
Of course there is a huge difference between a $15,000 working capital loan and a $325,000 working capital loan for the same business owner averaging about $5,000 a month in income. The main caveat is that full documentation lenders do require at least one year of business tax returns at minimum, and usually have a higher credit score requirement of about 640+. Our recommended SBA loan provider Fundera, delivers low interest rate, full documentation working capital loans that will maximize your loan proceeds for business opportunities that require larger dollar amounts.
Business working capital loans can be a great resource for businesses at all stages of their development. New businesses can benefit from smaller amounts of fast and affordable growth capital, medium stage businesses can receive larger working capital amounts for advantageous business opportunities, and mature businesses should consider putting an affordable business line of credit in place for emergencies or immediate capital needs to avoid depleting cash reserves. Whatever your business capital needs are, there are a variety of affordable working capital financing options available for you.