Are you considering getting a working capital loan for your small business? In order to make the most of working capital financing, there are a few things to keep in mind.
First, understand what working capital financing is. Working capital—the amount left over when you subtract current liabilities from current assets—is the money you use to keep your business operating. It pays for things such as rent, payroll, inventory—your short-term expenses—as opposed to long-term loans, which you use for purchasing or investing in fixed assets such as equipment or real estate.
A working capital loan helps you get over the “hump” of a short-term cash shortfall.
For example, you might use a working capital loan to:
- Buy the materials you need to fill a large order that unexpectedly comes in
- Finance seasonal needs, such as a retailer buying inventory for the winter holidays
- Hire new employees to meet growing demand for your product or service
- Pay bills while you wait for a major customer to pay an outstanding invoice
Basically, working capital financing can be used to handle any day-to-day business expense. How do you ensure you maximize the money you’ve obtained? Follow these steps:
1. Have a plan
Many methods of working capital financing involve rapid approval and minimal paperwork, which may make the loan seem like “no big deal.” Still, whether you obtain your working capital loan from a traditional bank or an alternative lender, you need to treat it with the same forethought.
Create a detailed plan for how you will use the working capital financing you receive, including cash flow projections showing how the injection of capital will help your business. Just because you get financing doesn’t mean you’re in the clear: If your business doesn’t generate enough cash flow, you may soon find yourself in a cash crunch again. Planning helps prevent that.
2. Match the working capital financing source to the purpose
Ideally, you want to match your source of working capital to the period for which you’ll need the money. In other words, if you need money to tide you over for three months before a major customer pays you, you wouldn’t want a working capital loan with an 18-month term. This would lead to paying unnecessary interest long after your financial needs have been met.
3. Assess all the costs and fees associated with the working capital financing source
Working capital loans are typically unsecured and are approved and funded quickly. However, the tradeoff is that they generally have higher annual percentage rates (APRs) than traditional small business loans. In addition, there isn’t a lot of consistency in the way alternative lenders express their interest rates and fees. This makes it especially important to work out exactly how much you will pay for obtaining capital from each potential source. Only then can you get the most bang for your buck.
4. Factor payments into your accounts payable
Some working capital loans are paid back via monthly payments; others require daily repayments through funds drawn from your bank account or credit card sales. Don’t forget to factor the repayment amount and dates into your cash flow projections. Because working capital financing is generally short-term, know whether there is any type of penalty for paying the loan back early. If not, it may be to your advantage to do so and get it off your books.
By taking these steps before obtaining working capital financing, you’ll position your business to make the most of the money you receive.