Small Business Working Capital Loans: What They Are & How To Get One

Working capital loans provide businesses with the funds they need for daily operations. Small business owners can use these loans to cover short-term operational costs such as wages or inventory. Getting a working capital loan usually requires a credit check, proof of revenue, and collateral, depending on the lender and the specific type of loan.

What Is a Working Capital Loan

A working capital loan is a class of financing businesses use to finance their everyday operations. These loans are not intended for investment in long-term assets or for business expansion. Instead, they cover operational costs such as wages, rent, inventory, and other short-term expenses. Working capital loans may be a good fit for businesses with high seasonality or cyclical sales patterns that create gaps in cash flow.

While working capital loans provide businesses with funds to stay open during slow periods, it’s also common for companies to take out working capital loans before a busy season to stock up on inventory, add additional staff, and cover other anticipatory costs. 

When to Use Working Capital

Working capital loans can be a valuable form of financing in various situations. Here are some scenarios where a working capital loan can prove beneficial:

• Seasonal sales fluctuations: There can be significant cash flow gaps during off-peak seasons for businesses with a high seasonality or cyclical sales pattern. A working capital loan can bridge these gaps, allowing companies to maintain regular operations despite seasonal fluctuations in revenue.
• Business expansion: Working capital loans are not intended for business expansion, but they can be used to prepare for a busy season or an anticipated increase in business activity. For instance, a retailer can use a working capital loan to stock up on inventory before the holiday season to ensure they’re ready to meet the expected increase in demand.
• Unexpected expenses: A working capital loan can provide an infusion of cash to cover unexpected expenses such as an equipment breakdown, a sudden need for extra staff, or an unexpected drop-off in sales. 
• Cash flow cushion: Even in the absence of immediate financial stress, businesses may choose to secure a working capital loan to provide a safety net or cushion. Having additional capital can offer a sense of security and enable businesses to seize unexpected opportunities that require ready access to cash.

How to Get a Small Business Working Capital Loan

Depending on your industry, getting a working capital loan for your small business can be involved. But, with the proper preparation, the process can be smooth and straightforward. Here are the general steps to getting a working capital loan for your business. Follow these steps to get a small business working capital loan:

1. Review your financials. Before approaching lenders, ensure your financial statements, credit history, and cash flow projections are all in order. Lenders will scrutinize these documents to assess your ability to repay a loan. Check your credit and take steps to improve your credit score if necessary, such as paying down other debts or disputing inaccuracies on your credit report.
2. Research potential lenders. Not all lenders offer the same loan products or terms, so research a variety of lenders, including traditional banks, online lenders, and credit unions. Consider the types of loans each offers, how you can use them, interest rates, loan terms, and repayment schedules.
3. Prepare your loan application. Once you choose a lender and a loan type, start working on an application. This usually includes providing information about your business and you personally, financial statements, personal and business credit scores, legal documents, and a detailed proposal outlining how you intend to use the loan.
4. Submit your application. After your application is complete, submit it to the lender. Be prepared to answer additional questions or provide additional documentation if requested.
5. Review loan terms. If your loan is approved, the lender will provide a loan agreement outlining the terms and conditions. Review this document carefully, and have it reviewed by an attorney if you need help understanding your rights and obligations.
6. Receive funds. Once you agree to the loan terms, the funds will be disbursed directly into your business bank account or by check. If you’re using a line of credit, funds may not be disbursed until you make a withdrawal request.
7. Manage your loan. After receiving the loan, you’ll need to make any required payments in full and on time to avoid damaging your credit score.

How Much Working Capital Should Your Small Business Have?

The amount of money your business should have for working capital varies depending on your industry and the nature and scale of your operations. Generally, businesses should at least maintain positive working capital, where current assets are greater than current liabilities. Doing so ensures your business can meet its short-term liabilities, such as payroll, rent, and operational expenses. 

Additionally, if your business regularly encounters unexpected expenses or opportunities that require quick access to cash, having excess working capital in the form of cash or ready access to credit can also be beneficial. 

However, holding too much idle cash can limit your business’s growth potential, as you could invest those funds in scaling operations or pursuing market opportunities.

If you have an established business, a good rule of thumb is to have enough working capital (either cash or access to approved credit) to cover at least three to six months of operating expenses. This can provide a safety net to weather temporary difficulties or unexpected costs. 

To determine your specific needs more accurately, consider seeking advice from a financial advisor or using ratios such as the current ratio or quick ratio, which can provide insights into the financial health of your business relative to industry averages.