Working capital loans—short-term financing business owners can use to cover operational costs—are best for seasonal businesses and those that need an occasional cash infusion to stay afloat. Common working capital loans include terms loans, lines of credit, U.S. Small Business Administration (SBA) loans and invoice factoring. Understanding how these loans work can help you understand when your business should get one.

What Is a Working Capital Loan?

A working capital loan is financing a business can use to pay for day-to-day operations. This may include covering payroll, making debt payments, restocking inventory and staying current on rent. Working capital loans are typically offered by traditional banks, credit unions and online lenders.

Annual percentage rates (APRs) may be lower than for long-term business loans but can still range anywhere from 3% up to 99%. That said, qualification requirements also may be less stringent than for long-term business loans, especially through online lenders. Overall, working capital loans are ideal for seasonal businesses and other operations that need short-term access to funds.

When You Should Consider a Working Capital Loan

A working capital loan may be helpful to business owners who are struggling to cover the day-to-day operational costs or need to finance temporary expenses for inventory, payroll or supplies. Keep in mind, however, owners shouldn’t use working capital loans to cover long-term expenses like expanding a business or financing expensive equipment.

Some situations where a business owner should consider a working capital loan include when:

  • The business needs money to cover payroll or rent until outstanding invoices are paid
  • Sales are seasonal or otherwise cyclical, and the business experiences annual dips in revenue
  • Manufacturing needs are greater during low-revenue months, and the business needs to cover production costs while finances are tight

Types of Working Capital Loans

Working capital loans can help business owners fill gaps in funding, make up for seasonal fluctuations in revenue and cover payroll costs. What’s more, business owners can choose from several types of working capital loans to meet these varied needs, including term loans, lines of credit, SBA loans and invoice factoring.

Term Loans

A term loan is a type of financing extended by a bank, online lender or other financial institution that must be repaid over a set period of time—usually anywhere from a few months to 25 years. Loan amounts typically span from $2,000 to $500,000, and interest rates can range from 6% to 99%.

Related: Best Small Business Loans

Business Lines of Credit

Business lines of credit let borrowers draw against a set amount of money on an as-needed basis. Instead of receiving money as a lump sum, a business owner can access the line of credit during the draw period, which usually lasts up to five years. Credit limits generally range from $2,000 to $250,000, and APRs extend anywhere from 10% to 99%.

SBA Loans

SBA loans are backed by the U.S. Small Business Administration and are intended to help small business owners start, maintain and grow their businesses. There are a number of SBA loan programs intended for different purposes, circumstances and applicant qualifications—each with its own loan amounts, terms and rates. Popular SBA loan programs for working capital include:

  • SBA 7(a) loans. The SBA’s 7(a) loan program is the administration’s primary business loan offering. Loans are available up to $5 million and can be used for working capital, but they are also appropriate for buying real estate, refinancing debt and purchasing business supplies. As of Nov. 3, 2021, SBA 7(a) loan interest rates range from 5.5% to 9.75%.
  • CAPLines. Part of the 7(a) program, CAPLines are loans meant to provide small businesses working capital for short-term and cyclical—or seasonal—needs. Borrowers can choose from the Contract CAPLine loan, a seasonal line of credit, a builders line of credit and a working capital line of credit—all with $5 million borrowing limits and maximum 10-year repayment terms.
  • SBA Microloans. SBA Microloans are available to eligible small businesses that need financial assistance to get started or expand. Funds can be used for working capital, as well as the purchase of equipment and machinery, inventory and other operational costs.  Loan amounts are available up to $50,000, and rates vary by lender but range from 8% to 13%.

Invoice Factoring

Invoice factoring is the process of selling a business’ invoices to a third-party invoice factoring company for a fee in exchange for a portion of the outstanding balances—generally around 85% to 95% of the total value. Once the invoices are sold, the factoring company is responsible for collections. The business receives the remainder of the funds minus any fees once the factoring company collects the invoices.

Invoice factoring enables small businesses to get cash quickly without qualifying for a traditional loan and wading through a lengthy loan application process.

How to Get a Working Capital Loan

The process for getting a working capital loan depends largely on the type of loan and the lender. However, there are a few steps you’re likely to encounter when applying for such a loan. Follow these general steps to get a working capital loan:

1. Evaluate your borrowing needs. If you suspect your business may benefit from a working capital loan, spend some time evaluating how much you need to borrow and for how long. Consider how much you can afford to make in payments each month and whether you need a lump-sum cash infusion or a line of credit you can access on an as-needed basis.

2. Check your business and personal credit scores. If your business has its own credit profile, lenders will evaluate both your business and personal credit scores. Before you apply, check your scores to evaluate your approval odds. It’s necessary to have a personal FICO Score of at least 530 to qualify for a working capital loan. However, a score of 600 or higher will qualify you for better rates and terms.

3. Research and compare lenders. Once you know how much you need to borrow and whether you’re likely to qualify, research lenders with loan amounts and qualification requirements that fit your needs. Compare banks, credit unions and online lenders based on available interest rates, repayment terms and fees. Then, spend some time reading customer reviews to evaluate each lender’s reputation.

4. Gather required documentation. Required documents may vary by lender. However, most financial institutions require business loan applicants to provide information about existing business loans and submit at least 12 months of personal and business bank statements, plus tax returns for a minimum of two years. You also may need to provide a detailed business plan—especially if you own a startup.

5. Submit a formal loan application. When your documentation is ready, submit a formal loan application through the lender’s website or at a branch. Procedures vary, but most lenders contact the prospective borrower via phone or email to request any additional information before processing the application, making a loan offer and sending it to underwriting. Many lenders also let you check your application status online.

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