To define a working capital loan in the simplest terms, one might say that it is a loan whose purpose is to finance everyday operations of a company. Anybody who has ever owned a business, or is running one currently, would know that a business often faces an urgent need of funds to keep operating smoothly. It may also find itself in need of funds in order to expand and grow. Under such circumstances, a working capital loan can be a veritable life saver.
A typical business falls into a need for cash for many reasons. It could be to purchase new equipment for your business or to expand the existing inventory by adding new items, or to open new branches and centers of operation at new locations (or to remodel or reconstruct existing ones), or to embark on advertising and promotional programs, or to pay off existing debts quickly. A working capital loan deftly takes care of all such financial needs. Simply put, for any business in need of some quick financing, a working capital loan is always an excellent option to consider.
Working capital loan is one of the two basic means of procuring emergency business funding. The other one is called business cash advance. Both these variants come with their share of pros and cons. One is well advised to look into the features of both and then decide on the best option for his business.
A working capital loan can be both secured and unsecured. A secured loan is one that is backed by an asset and/or personal guarantee. This asset can be a house, factory or inventory. Such loans can be fully paid up assets or assets with existing mortgages or loans. How much collateral the bank or financial institution will ask for depends very much on their assessment of your ability to pay back the loan. The bank may also require personal guarantees from the owners and/or directors. They must be ready and willing to put up their own personal assets to back the loan e.g. family home, shares and stocks.
Lenders give unsecured loans only to borrowers whom they consider to be low or no risk. Start-ups are generally viewed as risky and are unlikely to be granted unsecured loans.
As stated earlier, a working capital loan comes with its share of advantages and disadvantages. Among the main advantages is the fact that it is a great source of quick cash that can help a business tide over cyclical downturns. Working capital loans can be used to provide cash flow during short-term shocks e.g. when your key customer is declared bankrupt.
Among the disadvantages is the fact is that a working capital loan can only be used to meet a short-term cash need. These loans are generally insufficient for long-term plans or projects that require more capital (cash or asset). One also needs to monitor the loans closely and must ensure to repay them on time to avoid being blacklisted by credit bureaus and lending institutions.
