As a small business owner, you may be considering a working capital line of credit to help with cash flow. This guide will provide everything you need to know about how these lines of credit work and what to consider before applying. The right information can help you make the best borrowing decision, ensuring adequate cash flow to cover planned and unplanned business expenses.
The money you have available to pay for your short-term business expenses is your working capital. Also referred to as "net working capital" (NWC), you get to this number by subtracting your liabilities (e.g., expenses) from your assets (e.g., equity).
Your working capital is any equity that remains after you pay your short-term debts and expenses. It's important to have positive working capital because it shows that your business can cover its day-to-day expenses and have money left over for growth. A positive working capital is also something you can borrow against.
A working capital line of credit is a loan that provides your small business with access to funds as needed. This type of financing is helpful if you experience irregular cash flow or need short-term financing for inventory or other expenses. Working capital loans are tremendously helpful to small businesses. They can provide a safety net to cover gaps in cash availability.
A working capital business line of credit works like a credit card or traditional loan in that you're approved for a certain amount of funds. You access the credit when you need it and pay the balance monthly, just like with a credit card or standard loan.
For example, let's say your small business is approved for a $50,000 working capital line of credit and you use a partial amount — say, $5,000 — to cover payroll and inventory for two months. You only need to pay back the interest on the amount you borrowed, versus the full $50,000 as you would with a long-term loan.
This type of financing is helpful if you don't want to take on more debt than necessary.
The advantages of a working capital line of credit are compelling, particularly for small businesses that may not have the credit history or collateral for a long-term bank loan. Working capital lines offer flexibility, financial security, and a stress-free way to help you manage cash flow.
There are several points to consider before applying for a working capital line of credit, such as your business’s needs and financial situation. This type of financing isn't right for every business, so it’s important to do your research and understand the pros and cons before deciding. Potential disadvantages include:
There's often confusion between working capital lines of credit and business lines of credit. While both can provide much-needed financing for small businesses, there are some key differences to be aware of.
A business line of credit is a loan that allows you to borrow up to a certain amount of money (usually based on your annual revenue) which you can access as needed. Withdrawing funds doesn't require approval from the bank. This makes it easier to access the funds when you need them.
As with a business line of credit, a working capital line of credit is specifically for businesses that need financing to cover day-to-day operating expenses, such as inventory, payroll, or rent. The main difference is that it's typically easier for businesses to qualify for a working capital line of credit versus a business line of credit. Interest rates can be lower for this type of loan since it's based on your business equity. Approval and fund withdrawal move faster too, with a shorter wait time from application to approval.
Here are some examples of how you can use your working capital line of credit:
The terms of a working capital line of credit vary by lender. The amount you can withdraw and how fast you can withdraw it varies as well. Once approved, you may receive funding in 1-2 days.
Interest rates on working capital lines of credit are usually variable, which means they can go up or down over time. However, some lenders may offer a fixed rate for a promotional period (e.g., the first 6 or 12 months).
The amount you can borrow will depend on the lender, but typically ranges from $1,000 to as much as $5 million. And, because it's a revolving loan, you can continue to access funds if you don't exceed your credit limit. It's important to communicate with the lender and make sure you understand the fees and rates you're responsible for paying.
Repayment terms vary depending on the lender, but typically range from six months to five years. Loan renewal is contingent upon meeting certain criteria, such as maintaining a good credit score and making regular, on-time payments.
Keep in mind that a variable interest rate can increase over time. Thus, it can be challenging to budget for your loan repayments. Also, some lenders require collateral to secure the loan — real estate, a personal line of credit, etc. — meaning your business or personal assets are at risk if you can’t repay your loan.
One of the most important things you can do when committing to a working capital line of credit, is to understand the terms. Make sure you know your responsibilities and that you’re comfortable with the loan’s terms and requirements.
Now that you know how working capital lines of credit work, you can decide if this type of financing is right for your business. Aion offers credit lines ranging from $10,000 to $2 million with transparent pricing, and same-day funding options.
You can apply for capital in minutes and receive a proposal within 24 hours. Get started creating an Aion account today.