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Updated: November 10th, 2020
Simply put, working capital is the amount of money your business has on hand to cover day-to-day operating expenses and is essential for, well, keeping your business working. Whether you own a bakery, barbershop, or fitness studio, you require a certain amount of cash on hand to keep your operation afloat–that’s your working capital.
If you’re struggling month-to-month to pay your bills or don’t want to put a dent in your existing cash reserves to finance a growth opportunity, a working capital loan may be right for you. Here’s what you need to know.
Working capital is the amount of cash a business has on hand to cover day-to-day business expenses: payroll, electricity bills, supplies, and rent, to name just a few. If you want to increase your cash flow and don’t want to take on a long-term debt obligation, a working loan could be a good fit for you.
Your working capital can be calculated using the following formula (with the information available on your balance sheet):
Working Capital = Current Assets – Current Liabilities
Let’s take a look at a sample balance sheet as an example:
If your business has $300,000 in current assets and $150,000 in current liabilities, your working capital would be $150,000. However, looking at only a dollar amount isn’t necessarily a good way to take measure of a company and its financial health.
That’s where the working capital ratio comes into play (also known as “current ratio”). The following formula is used to calculate your working capital ratio:
That’s where the working capital ratio comes into play (also known as “current ratio”):
Working Capital Ratio = Current Assets / Current Liabilities
Using the same example from above:
Working Capital Ratio = $300,000 / $150,000 = 2
A working capital ratio lower than 1 means your company has negative working capital, whereas a working capital ratio between 1.2 and 2 means your company has positive working capital.
Calculating your working capital ratio is helpful because it offers some quick insight into your financial standing and helps you understand how well positioned you are to cover short term expenses.
For example, your business and available working capital may be growing year-over-year, but if your liabilities are increasing at a similar rate, this could signify some upcoming liquidity issues. The working capital ratio gives you a more holistic understanding of the financial status of your business, especially when analyzed on an annual basis.
If your working capital ratio is trending toward stagnant or decreasing, it may indicate that it’s time to tighten your operations and explore your financing options.
Healthy cash flow is vital for all businesses, but it becomes especially important when you’re trying to expand and grow. As the saying goes, “It takes money to make money.” Even if your current capital can keep your business out of the red in its current operating state, you may need an injection of capital if you are planning to increase production or scale-up your operation in another way.
Whether you find yourself with a tight operating margin or simply have an opportunity that you can’t afford to turn down, a working capital loan could be the right financing solution for your business.
“We just needed flexibility. The money will get paid back on the sales we do. But we need the money to pay for things upfront, because everything we do is paid for upfront. Before we even get product we pay for it.”
Take Elijah’s Xtreme, a hot sauce company run by the father and son team, Elijah and Bret Morey. While sales were strong and they were winning awards for their homemade hot sauces, they were running into an issue many companies face — since they had to pay for inventory in advance, they were constantly strapped for cash.
With a small business loan from Funding Circle, Elijah’s Xtreme was able to launch two more products. Even better? They’ve been able to launch even more products with the money they’ve made from their new offerings.
Determining the right amount of capital to borrow can be tricky. Borrow too much, and you could be in over your head with debt; borrow too little, and you may end up with a half-baked vision, unable to hit your break-even point.
One strategy to help you determine the right amount to borrow is to try thinking like a lender and consider your “capacity.” Capacity, in this context, is your business’ ability to repay the loan. What do your cash flow projections look like? How will the money you borrow contribute to the trajectory of your business? How much money do you need to get the job done?
For example, if you’re considering expanding your fitness studio to a second location, it’s so important to make sure you are accounting for the full spectrum of expenses. It’s probably not enough to only consider the upfront, obvious costs like renovations, purchasing equipment, and the first few months of rent; you’ll also need to take into account other fixed and variable expenses like utilities, hiring instructors and other , cleaning costs, insurance, licensing fees, advertising and marketing, supplies, and payroll. Do you need a real estate broker to show you locations or a lawyer to review your lease? Did you take into account seasonal ebbs and flows in business (New Year’s resolutions, anyone)?
Working through these questions and calculations and making sure you have a realistic sense of expenses will give you a better idea of exactly how much money you need to take the financial pressure off your business to either sustain operations or pursue growth.
A business loan can do wonders for your cash flow, freeing up capital that otherwise would not be available. You can use the funds for almost any business purpose. This includes taking advantage of new opportunities and covering unexpected expenses. Here are a handful of common use-cases:
As a general rule of thumb, you can never be too prepared when it comes to applying for a small business loan. If you have your books in order and the necessary documents compiled when you first meet with a lender, it sends a great signal and allows you to move much faster. Here are some tips to get you started:
Working capital loans come in many different forms: term loans, lines of credit, invoice financing, SBA loans, and merchant cash advances (MCAs). It’s crucial to choose the right type of financing (and lender) to help you meet your goals. With this in mind, here are a few things that you should consider when researching small business loans:
Cash flow is the lifeblood of your business. If you are looking to increase your cash flow without taking on a long-term debt obligation, a working capital loan might be the best small business loan for you. If you want to see your options and compare rates, get started with our application—it takes less than 6 minutes, which means you can focus your time where it matters most while your dedicated loan specialist takes care of the rest.
Why should I get business capital from Funding Circle?
Funding Circle was created with a big idea: to revolutionize the outdated lending system and build a better deal for small businesses. With one 6 minute application we can help you find the right financing options for your needs, from lines of credit to term loans, cash advance and even Small Business Administration (SBA) loans. Let’s get started.
Are working capital loans secured or unsecured?
Lenders may offer either secured or unsecured working capital loans. A secured loan requires that you provide your business’ assets, and sometimes your personal assets, as collateral for the loan. While secured business loans may be easier to qualify for or offer lower fees, you’re also taking on additional risk. Unsecured loans, like the business capital loans from Funding Circle’s lending partner, might cost a little more but they don’t require collateral.
How does repayment work?
Repaying a working capital loan can depend on the type of loan you receive and the lender. Funding Circle’s working capital lending partner offers daily and weekly repayments. Once you receive your working capital loan, your payments will be automatically transferred from your linked business bank account until you’ve repaid the entire loan amount. The repayment terms generally range from six to 18 months.
Louis DeNicola is the president of LD Money Media LLC and an experienced finance writer who specializes in credit, personal finance, and small business finance. Within the small business sphere, he helps business owners understand their financing options, cash flow management, business credit, and taxes. In addition to Funding Circle, you can find his work on BlueVine, Credit Karma, Experian, Wirecutter, and Lending Tree.