A working capital loan is designed specifically to boost your working capital so you can cover short-term debts, such as payroll, utilities, and rent. Generally, working capital loans are different from long-term debt obligations such as mortgages. There are pros and cons to this type of funding, and you should consider several factors before making your final decision.
In most cases, business owners turn to working capital loans when they don’t have enough cash on hand to keep up with their current bills. If you’re struggling financially, adding more debt may make matters even more difficult. Before taking out a working capital loan, consider doing a cash flow projection so you can determine if you can handle the repayments.
One instance where working capital loans really make sense is when you anticipate an upcoming boost in revenue. For example, if your business is seasonal, and you know that revenue is likely to pick up in a month or so, you may want to use a working capital loan to get you through the off season. Similarly, a working capital loan can also help if you’ve lined up a big contract and you just need some help until you receive that payment.
If you decide you can handle the repayments, consider the interest rate on the loan. Anytime you incur loan interest or fees, you’re essentially paying to use money. When it comes to loans for large purchases such as buildings, it makes sense to pay this extra money; without that loan, you typically wouldn’t be able to afford those assets. On the flip side of the coin, if you’re just using a loan to cover day-to-day expenses, you may not want to pay extra for those funds. Instead, you may want to focus on reducing your current expenses so you can avoid taking out a working capital loan. If you decide to take out a loan, you can claim the interest as a business expense on your tax return.
When you take out a working capital loan, you generally use the funds as working capital. You could also use these loans for large capital purchases. Some of the lenders that offer working capital loans focus specifically on entrepreneurs with poor credit. If you need funding, and you’re worried about your credit rating, you may want to contact a working capital lender simply because of the flexibility built into the approval process.
Many working capital loans are unsecured loans, and you don’t have to put up collateral to secure these loans. In other cases, lenders may require collateral. For example, if you get a working capital line of credit, the lender may use your personal home or significant business assets as collateral. You have to decide if you feel comfortable with the risks involved with using your assets as collateral. Working capital loans can be ideal in financial emergencies when you don’t have enough cash on hand to cover your bills, but the repayment schedules can put additional unnecessary strain on your available capital. Ultimately, you need to weigh the potential benefits and decide if it’s right for you.