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The Ultimate Guide to Working Capital Loans
April 20, 2021
Working Capital Loans - Our Ultimate Guide

The Ultimate Guide to Working Capital Loans

If you’re a small business owner, you already know how to make the most out of scarce resources. That said, working capital loans may be a tool that you’ve previously overlooked.

Working capital loans provide funds for you to pay for operational expenses, purchase inventory, or finance short-term initiatives. In doing so, these loans can free you up to capitalize on timely growth opportunities or solve short-term cash flow problems.

However, there are many types of business financing you can use to shore up your working capital. These various types have their benefits and drawbacks, which may or may not make them a good fit for your business’s financial needs.

To help you navigate this landscape, in this post, we’ll review 1) what a working capital loan is, 2) how the application process and repayment works, and 3) how working capital business loans can be used.

What is a Working Capital Loan?

A working capital loan is a short-term loan provided by a financial institution or alternative lender to finance daily business operations. Different types of small business loans include:

  • Term loans
  • Merchant cash advances
  • Invoice factoring
  • Business lines of credit
  • Business credit cards
  • Bridge financing
  • Inventory loans
  • Equipment financing

Regardless of type, the point of a working capital loan is to finance short-term expenses like rent, wages, debt payments, or company initiatives.

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How Can You Use a Working Capital Loan?

To understand how you can use a working capital loan, it’s important to know what working capital is and how you can utilize it.

You can read this post for more information on working capital but Thomas Stewart, Executive Director at National Center for the Middle Market explains it like this:

“In the ordinary course of business, [working capital is] money that you have tied up doing the things you need to do.”

This includes money tied up in the following:

  • Short-term debt
  • Accounts payable
  • Inventory
  • Taxes owed

All of the examples included above are considered types of working capital. As the name implies, you can use a working capital loan for any short-term expense associated with your business operations.

The only caveat is some types of working capital loans have specific restrictions on your use of funds. To make things easy, the following two sections list working capital loans based on their use of funds limits.

Working Capital Loans with No Use of Funds Restrictions:

The following types of working capital business loans have no restrictions on how you can use the funds:

  1. Loans from alternative lenders
  2. Merchant cash advance
  3. Invoice factoring
  4. Business credit cards
  5. Business lines of credit

This means you can use these loans for anything from paying down debt to purchasing more inventory.

We suggest pursuing a financing option that doesn’t have usage restrictions so that you can utilize your funding however you’d like.

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Working Capital Loans with Use of Funds Restrictions:

The following types of working capital loans have specific restrictions on how you use your funds:

  1. Term loans (SBA Loans and some bank loans)
  2. Bridge financing
  3. Inventory loans
  4. Equipment financing

Each of these types of loans has different restrictions. For example, inventory loans and equipment financing can only be used for inventory and equipment, respectively.

With term loans and bridge financing, use of funds isn’t as black and white. That is, some term and bridge lenders may be more or less restrictive as to how you use the funds. You’ll need to inquire with individual lenders about these restrictions.

How to Apply and Qualify for a Working Capital Loan:

The precise steps you take to apply for a working capital loan will depend on the lender and type of loan. Still, there are several things you can do to prepare yourself, regardless of lender or loan.

To that end, we recommend following these five steps when applying for a working capital loan:

  1. Understand the different types of working capital business loans.
  2. Prepare your business bank statements.
  3. Check your credit score and verify that it meets the lenders prerequisites.
  4. Communicate with your business lender about existing debt.
  5. Determine how you’ll use your working capital in the long term.

For more information on applying and qualifying for working capital loans, read our post: How to Apply for Working Capital From a Lender.

Conclusion: Be Prepared to Repay a Working Capital Loan

As you might expect, how you repay a working capital loan depends on the kind of loan you get.

For example, the repayment terms of a term loan and a merchant cash advance are completely different.

With a term loan, you generally pay your balance back in fixed, monthly payments. Yet even just among term loans, repayment schedules can vary significantly. You might have an interest-only period or a variable interest rate, both of which can change how you repay the loan.

This contrasts with merchant cash advances, which you fulfill your obligation with daily or weekly remittance of your credit or debit card sales. In any case, the point is that there’s no one way that the repayment process works for working capital loans.

Therefore, if you’d like to learn more about specific kinds of working capital loans, check out the guides that we’ve put together below:

Fora Financial

Editorial Note: Any opinions, analyses, reviews or recommendations expressed in this article are those of the author's alone, and have not been reviewed, approved, or otherwise endorsed by any of these entities.

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Fora Financial is a working capital provider to small business owners nationwide. In addition, the Fora Financial team provides educational information to the small business community through their blog, which covers topics such as business financing, marketing, technology, and much more. If you’d like to see a topic covered on the Fora Financial blog, or want to submit a guest post, please email us at [email protected].