One of the biggest challenges small business owners face on a regular basis is the inherent need for “working capital”, the cash used to finance a company’s short-term operational expenses, such as payroll, paying invoices, and purchasing inventory. Without it, the business cannot operate.
Since most businesses don’t have a stable income throughout the year, maintaining a steady supply of working capital can be tricky. This is particularly true for businesses that have high seasonality or cyclical sales, which usually experience reduced business activity a few times a year.
Producing an annual net working capital with more liabilities than current assets is tantamount to income loss and is a precursor to insolvency. Business owners avoid such a problem by relying on working capital loans for small business provided by lenders. This is the most financially sensible choice to make, because current liabilities could pile up much faster when operation stalls due to lack of working capital than when the company has a short-term debt.
When to Consider Taking Out a Working Capital Loan
While working capital is generally meant to cover a company’s short-term, regular expenses, there’s a range of situations in which it may come in handy.
- Sales Rush. Peak seasons are exciting times for retailers, but they also come with huge outlays, particularly additional manpower to manage the sales rush. Borrowing working capital can help you cover all extra expenses you will need to get through the hype.
- A Threat to Cancel. Competition can be cut-throat sometimes, and if you’re not sharp enough, you could lose some of your clients to your competitors in a heartbeat. When an important client threatens to discontinue your service, your only option to convince them to stay is to offer a deal too sweet to resist. Rather than lose a big chunk of your revenue and scathe your reputation by letting go, outmatching your competitor’s offer makes much more financial sense, and a working capital business loan can help you achieve that.
- Upgrade. Are you planning to buy new machines or renovate a section of your building to improve your services but you lack funds due to the significant volume of invoices? If you think the upgrade can’t wait any longer, consider taking out a working capital loan to cover it. Then you can use the receivables to settle the loan.
- Lengthy Production. Some products take some time to produce, which is why manufacturers require their customers to place their order several weeks to a few months before to give them enough leeway for production. If an order happens to be urgent and it’s too big to turn down, you may use a working capital loan to cover initial production expenses.
Pros and Cons
Just like any other type of loan, a working capital loan has its fair share of benefits and drawbacks. It’s important to know what this loan can and cannot do for you so that you can minimize as much of the risks it entails as possible and maximize its financing power.
Pros. As previously discussed, a working capital loan can help fuel your short-term needs. As it turns out, it has many other benefits that you can enjoy. For instance, because it is classified as “unsecured loan”, it usually doesn’t require a collateral as an assurance of repayment. While you don’t intend to default, at the very least, you can rest assured that none of your assets are up for grabs.
Working capital loans are easy to secure, too, with no more than a few sheets to fill out and basic documents to submit. Some lenders even allow online transaction to make it more convenient for borrowers. Processing and approval usually takes 48 hours and the cash can be disbursed in different ways. With flexible payment tenors, planning the most effective way to pay your debt is much easier as well.
Cons. Risks have to be expected when borrowing a huge sum of money, especially if you have no guaranteed source of fund to pay for it within the agreed timeframe. If you take out a working capital loan when the economy is bad, your creditor might require you to put up a collateral or charge a high interest rate to curtail their risk.
It’s also likely that the creditor will require relatively quick repayment. It only makes sense, though, since working capital loans are meant to cover short-term expenses. This is why it is vital to ensure that you are expecting future cash to settle your debt in time.
To manage as many risks as possible, your best course of action is to pick the right lender. One that is both lenient and reasonable, just like Australian lender IBN Direct. This way, you can make sure that the terms favor both parties and that you won’t fall prey to some kind of scheme.