A working capital loan is taken to finance a company’s everyday operations. These loans are not used to buy any long-term assets or to make investments; they are instead used to provide the capital to cover day-to-day needs.
These needs could include costs like payroll, rent and debt payments. Because of this, working capital loans are, in essence, corporate debt borrowings. They are also often used by cyclical businesses during off-seasons, the debt of which is paid down during the busy season. Working capital loans are a flexible option for small businesses in need of quick cash to cover immediate expenses.
Pros and cons of working capital loans
The immediate benefit of working capital loans is that they are easy to obtain. They allow business owners to efficiently cover any gaps in expenditure. The other noticeable benefit is that it is a form of debt financing and doesn’t require an equity transaction, meaning that a business owner maintains full control of their company even if the financing need is dire.
Some working capital loans are unsecured, meaning they will only be available to business owners with a high credit rating. Other working capital loans are collateralised, leading to high interest rates to compensate the lending institution for risk. Furthermore, they are often tied to a business owner’s personal credit and any missed payments or defaults may hurt their credit score.