Working capital loans: everything you need to know

Working capital is the money a business has available to cover its everyday expenses. It’s the difference between what’s coming in over the short term, such as cash and invoices due from customers, and what you owe, such as bills from suppliers, wages and short-term debts.

If your outgoings start to outweigh what’s coming in, you may face a working capital gap. In this case, a working capital loan can provide a temporary cash boost to keep your business running smoothly.

At a glance

• Working capital refers to the money a business has to cover day-to-day expenses

• A working capital loan can help bridge short-term cash flow gaps

• You typically repay a working capital loan within 12 months, although some loans come with longer terms

• You can choose from both secured and unsecured working capital loans

• You typically receive your cash the same day, although secured loans can take longer to process

What is a working capital loan?

A working capital loan is a type of business loan that you can use to cover everyday costs such as payroll, rent and debt payments. This differs from other types of business loans that you might typically use to invest in long-term assets or growth opportunities. 

Primarily designed for new and small businesses, working capital loans are short- to medium-term loans that you usually repay within 12 months. However, some working capital loans have terms of up to two years.

When applying for a working capital loan, you should receive your funding within 24 hours to a couple of days, with the amount you can borrow depending on your company’s size and financial situation, as well as the type of loan you choose.

How do working capital loans work?

If you apply for a working capital loan and the lender approves your application, you receive the funds in your nominated business bank account.

You can then start to use this cash to help with business expenses, including buying stock, paying suppliers and covering wages. 

You must also start making your monthly repayments over the pre-agreed term of the loan. These repayments include interest and potentially other charges, too. At the end of the term, you’ll have repaid the loan in full.

What are the different types of working capital loans?

There are two main types of working capital loans – secured and unsecured. You can also apply for short-term and medium-term working capital loans.

Unsecured working capital loans

An unsecured loan does not require the use of an asset as security. Whether a lender approves you for a loan depends on your business credit history, trading record and strength of your business. However, you typically pay higher rates of interest and lenders may cap the loan size.

Secured working capital loans

With a secured working capital loan, you must pledge an asset, such as property, vehicles or equipment, as security. Because of this, you’re more likely to qualify for a secured loan if you have poor credit, and interest rates tend to be lower. You can usually borrow larger sums, too.

The downside is that should you fail to repay your loan, the lender has the right to seize the asset to recover its money.

Short-term working capital loans

Short-term working capital loans have repayment terms of just a few months, and you should receive your funds quickly. However, monthly repayments can be relatively high.

Medium-term working capital loans

Medium-term working capital loans come with slightly longer repayment terms, usually up to a maximum of two years. Longer repayment terms can bring down the cost of your monthly repayments, but also mean you pay more interest overall. 

Who is eligible for a working capital loan?

Eligibility criteria vary depending on the lender. However, generally, lenders look for the following:

• UK-based business with a trading history of at least six to 12 months 

• A steady turnover that shows you can afford your repayments. Minimum thresholds vary by lender

• A good business credit score. Some lenders may accept businesses with a poor credit history but charge higher rates and limit borrowing amounts

• Sufficient collateral if you’re applying for a secured loan

What are the advantages of working capital loans?

There are several advantages to applying for a working capital loan, including:

• Improves cash flow – Working capital loans provide quick access to funds, helping you cover day-to-day expenses and prevent disruptions in operations

• Flexibility in use – You can use a working capital loan to cover any expenses – you don’t have to state the purpose of the loan

• Easy to apply – The application process is usually fast and you could receive your funds the same day

• Short-term solution – You should repay a working capital loan quickly, so you don’t take on long-term debt unnecessarily

• Builds credit – Provided you repay your loan on time, your business credit score should go up, which can help you get more credit in the future

• Secured and unsecured options – Choose which option works best for you

• Provides seasonal business support – If your business has both periods of high sales and times when sales are slow, a working capital loan can help cover expenses during those quieter times

What are the disadvantages of working capital loans?

As well as the advantages, it’s important to consider the downsides of working capital loans:

• High borrowing costs – Interest rates and fees can be high, especially for unsecured loans or short-term options

• Risk to assets – If you have a secured loan, you could lose your assets if you don’t repay your loan on time

• High repayments – Because working capital loans are short-term options, your monthly repayments can be high, which can strain cash flow if your revenue fluctuates

• Good credit history required – This is particularly the case for unsecured loans. If you miss a repayment, you could damage your personal and business credit score

• Risk of overborrowing – Relying on loans to cover regular expenses can mask deeper cash flow or profitability issues

• Loan must always be repaid – This applies even if your business goes under

• Could miss out on growth opportunities – By committing to monthly repayments, you may not be able to afford to take advantage of opportunities to expand your business

Is a working capital loan right for your business? 

A working capital loan can provide a financial lifeline if your business is struggling to cover day-to-day expenses or needs a short-term cash boost. It can be particularly helpful if you have predictable, short-term cash flow gaps and you need funds to pay suppliers, wages or other immediate costs. 

However, a working capital loan may not be right for your business if you rely on loans to fund ongoing operations, because this could indicate you have deeper financial issues. It’s also unlikely to be the best choice if your revenue fluctuates a lot and you could struggle to meet the repayments, or if you know you can’t afford the interest and fees charged. 

What to consider before applying for a working capital loan

Before applying for a loan, it’s crucial to consider how much you need to borrow and how quickly you can repay your loan, as well as whether the repayments will be affordable. Remember that if you can’t meet your repayments, you risk damaging your business credit score and your firm’s long-term financial health. 

Also consider whether there are any more suitable alternatives. If you’re not sure, it can be worth seeking financial advice. 

If you decide to go ahead and apply for a working capital loan, review the eligibility criteria for each lender to ensure you meet them. Then compare interest rates, fees and repayment terms to find the most competitive option. 

How to apply for a working capital loan

You can usually apply for a working capital loan online, although some lenders may ask you to apply in person. When completing the application form, you must provide all the relevant information and documents, such as cash flow records, bank statements, tax returns and, if you’ve chosen a secured loan, proof of assets.

Some lenders can review the information and give you an answer the same day. If the lender accepts your application, review your offer carefully before agreeing to it, to ensure the repayment terms work for you.

If the lender rejects your application, it’s best to wait a few months before applying again. That’s because each time you apply, the lender carries out a credit check. Too many credit checks in a short period of time can have a negative impact on your credit score. 

What are the alternatives? 

If you’re not sure whether a working capital loan is the right choice for your business, there are plenty of other funding options to explore. These include:

• Business credit cards – These allow you to borrow flexibly and can help cover business expenses as needed. Many also come with perks such as cashback and air miles. But interest rates can be high if you don’t repay the balance in full each month

• Business overdrafts – Many business bank accounts offer overdrafts that you can use as and when required to give you access to extra cash. The downside is that interest rates and charges are high, and you can’t borrow as much as you can with a loan

• Merchant cash advances – With this option, the lender gives you a lump sum of cash based on how much your business makes from card sales each month. You then repay this amount, plus fees, through a percentage of your card sales

• Invoice finance – This is a type of secured lending that lets you borrow up to 95% of the value of your customers’ invoices. You repay this amount once your customers have paid their invoices

• Asset finance – Designed to help cover the cost of business equipment, vehicles and machinery. Rather than paying for these assets up front, you pay for them in instalments. At the end of the agreement, you might own the asset outright, be able to return it, or have options to purchase it

Read more…

• Business loans explained

• Am I eligible for a business loan?

• How to get a business loan?