There are two basic definitions for business capital loans: working capital reserve. Simply put, working capital is what is needed to pay day-to day operating costs and is necessary for, well…keeping your business alive. The other definition, which is widely used, is called equity capital. Here’s why you need both.
It would be very misleading to talk about working capital loans and small business loan separately. They are very much connected. A working capital loan could be a small business loan with an interest rate that is much higher than a traditional small business loan and it could be a small business loan with terms that are very different from a traditional small business loan. So, one is not necessarily better than the other.
In order to understand the connection between a working capital loan and a small business loan, you have to understand your small business cash flow Business capital loans. You can get a business cash flow several ways: through credit card sales, through the sale of goods and services, through installment sales, and through endowing, among others. Your working capital consists of your inventory, minus your cost of good sold, less your retained earnings, less your expenses, minus your net worth, less your goodwill (if any), less your capital reserves, less your current liabilities, plus your cash flow. We can sum up all this in a statement: Net worth – current liabilities – net worth – capital reserves – cash flow.
What does this all mean? Well, for starters, if you want to take out a working capital loan and your cash flow is negative, you can’t do it. And you also can’t take out another line of credit, because your business would still be at risk. Now, a working capital loan could be used as collateral for another type of debt, such as an installment sale or a credit card debt. The problem with that is that when that debt is paid off with the sale proceeds, you end up owing money for money that was never paid. In other words, it’s a bad deal.
On the other hand, term loans are very useful for business owners who want to boost their cash flow. Usually, such short-term funding circles are easier to obtain and don’t involve the kind of credit score destruction that goes on with working capital loans. Term loans are almost always based on the business owner paying back a certain amount of money over a period of time. (Most lenders want to see at least a 3-month lag time before they consider offering you capital.) Therefore, if your business generates enough cash flow to pay the capital loan, it’s easy to extend the term.
However, if you don’t have enough working capital, you won’t be able to keep extensions going forever. And as the funding circle tightens, the costs will go up. If you need more cash flow, you’re going to have to find a way to get it to your customers faster. In this case, payday advance companies may be able to help. Some companies make it possible for you to take a small loan against your next paycheck, which can then be used to pay your short-term working capital loans.
However, even though some payday advance companies make it possible to take small working capital business loans against your next pay check, you should be aware that the rates you’ll be offered will typically be much higher than if you used your own funds. (It’s true that many banks and credit unions make such small business loans.) The reason for that is that these companies are able to finance your loan quickly, and in large amounts, since they have no real overhead.
However, if you’re really strapped for cash, it may be a good idea to use your own funds instead of taking out a payday advance. Keep in mind, though, that the rate you’ll be offered will be much higher than if you were to use cash. If you want to ensure that you have a high cash flow, it’s best to keep your current assets-current liabilities and your current debts current liabilities, both of which equal 100%. (For example, your business loan payment would include your personal guarantee of the loan.) You should also remember that working capital advances are different from commercial lines of credit, so it’s important to understand them as well.