Working capital loans help businesses cover everyday expenses and short-term goals when revenue doesn’t quite line up with expenses.

  • Working capital loans provide short-term funding to cover daily business expenses when cash flow is tight.
  • These loans may be best suited for operational needs that will generate revenue or stabilize finances within a few months.
  • Approval often depends on credit and business history, revenue consistency, and a demonstrated ability to repay the loan.
  • Responsible repayment planning and regular evaluation may help protect cash flow and ensure the loan fulfills its intended purpose.
  • Different working capital financing options can carry unique costs, application processing, and decisioning timeframes, so it’s important to choose the structure that fits your business needs.

Big picture planning may be able to keep a business healthy, but sometimes things don’t go exactly according to plan. Day-to-day operations depend on having cash to cover recurring expenses, such as payroll and equipment purchases. If cash flow slows even temporarily, it may put operations at risk. A working capital loan may help smooth short-term cash flow obstacles or help overcome unexpected expenses.

Understanding Working Capital Loans: What They Are and Who Should Consider Them 

What is a working capital loan? Let’s look at what working capital loans are and how they’re used.

Defining Working Capital Loans and Their Purpose

A working capital loan is financing specifically for short-term needs. Other types of business loans with different terms may offer better financing for long-term needs like real estate or business expansion, but a working capital loan supports the ongoing movement of cash through the business.

Some common uses may include: 

  • Covering payroll during slower revenue periods
  • Purchasing inventory for seasonal demand
  • Managing utility and rent payments
  • Bridging cash flow gaps while waiting on receivables
  • Supporting marketing campaigns or short-term growth initiatives

People sometimes say “it takes money to make money,” but that cliche may be difficult to implement for a business waiting on customers to pay a late invoice or marketing during the off-season. A working capital loan may provide funds to help get these short-term initiatives off the ground or to float the business until the next cycle of revenue.

Determining If a Working Capital Loan Fits Your Business Needs

Choosing a working capital loan over other forms of lending might depend on what your business’s goals are. One consideration is whether the initiative you’re funding will generate cash quickly enough to cover repayment. Because repayment terms are generally shorter, these loans might be better suited for operational needs expected to return value within 12 months or less.

For example, if a business depends heavily on seasonal cycles of purchasing, it may be a challenge to keep enough revenue for expenses during the other parts of the year. A working capital loan may provide extra capital to more easily handle operations until the next busy season arrives. A business might use a working capital loan to prepare for the next busy season as well by having cash to hire and train new workers before things get busy.

In another scenario, a business’s receivables are strong, but long payment terms may not align with when larger projects need to happen. A working capital loan might make it easier for a business to begin those projects, knowing that payments on invoices will be coming in soon. 

If potential profits or revenue related to the loan are expected to appear over multiple years, a working capital loan may put extra pressure on the business. A long-term loan, such as a fixed-interest business expansion loan, may align better with payments and reduce financial strain.

How To Get a Working Capital Loan: Eligibility, Application, and Approval

Who is eligible for a working capital loan? Here are a few things to keep in mind.

Key Eligibility Criteria for Working Capital Loans

Many lenders want to make sure that a business can pay back loans within the repayment terms. Each lender will have different terms and expectations, but here are some common requirements:

  • Business history, often at least 1-2 years in operation
  • Consistent revenue with financial statements demonstrating viability
  • A Strong credit score, either personal and/or business credit
  • Cash flow coverage with a documented ability to handle monthly repayments
  • Collateral for certain types of loans

Businesses without a long history may still be able to qualify, but likely with stricter terms or more reliance on personal credit. This might also need to be part of the consideration when choosing a working capital loan.

Step-by-Step Application Process for Working Capital Loans

The typical loan process may look different depending on your business and the lender you choose. Here are some common steps to applying for a working capital loan.

  1. Assess your financing needs to determine how much capital you require and whether your needs are best met with a working capital loan. This first step may help prevent overburdening the business with too much debt or straining finances with the wrong kind of loan.
  2. Choose a lender. Explore options from traditional banks, credit unions, and online lenders to find one that best suits your needs. Different lenders will have their own terms and loan choices, so it may help to look beyond your existing banking solution
  3. Prepare documentation to ensure that all necessary paperwork is available and correct. Again, different lenders may have individual documentation requirements based on the business model, history, and industry. Some commonly required documentation:
    • Business financial statements (cash flow, balance sheet, P&L)
    • Bank statements
    • Tax returns
    • Legal documents (EIN, business license)
    • A clear outline of how funds will be used
  4. Submit your application with all the required documentation. Carefully reviewing all the details helps prevent mistakes, smooths the application process, and reduces unnecessary delays.
  5. Review the loan terms once approved. Before signing any documents required to receive the loan, it is important to carefully review them. Carefully reading the documents is necessary to ensure you understand and are in agreement with the terms offered, your obligations, and the consequences of failing to comply with your obligations.
  6. Receive funds. In some cases, funding may only take a few days, but different lenders may have different timelines. 

Your chosen lender may be able to guide you on the specific documentation required to approve your loan.

Maximizing the Impact: Best Uses and Potential Limitations of Working Capital Loans 

A working capital loan may provide cash to help accomplish business goals, but let’s look at a few ways to work with them more effectively.

Smart Ways To Use Working Capital Loan Funds

A working capital loan may be used to cover many expenses, but it may be most effective when it directly supports revenue. For example:

  • Buying supplies and inventory or hiring and training additional employees ahead of a major seasonal sales cycle
  • Running short-term marketing and sales initiatives
  • Bridging gaps between customer payment cycles
  • Managing an unexpected delay or disruption in the supply chain or mistakes from suppliers

In each of these cases, the business expects revenue in the short term once the period or disruption passes. Paying back the working capital loan might not be so difficult.

Weighing Benefits and Disadvantages Before Borrowing

Like any financing tool, a working capital loan may be a really good option for certain situations and less than ideal in others. Here are a few considerations before taking on this type of debt.

Under the right circumstances, a working capital loan might benefit a company because it may:

  • Help prevent operational interruptions
  • Offer fast access through many lenders
  • Provide flexibility for temporary needs
  • Have unsecured options, reducing the requirement for collateral.

However, some potential drawbacks of a working capital loan include:

  • Shorter repayment periods, which might mean higher monthly payments
  • Higher interest rates than long-term loans, due to the nature of the loan
  • Difficulty covering repayments if the funds don’t generate the expected revenue outcomes.

A thorough accounting of the business and its financial picture may provide a better understanding of whether the company is capable of paying back the loan.

Comparing Common Working Capital Loan Options Without the Jargon

Small businesses may be able to choose from different types of working capital loan options. Responsible strategic borrowing by matching the loan to specific needs may help prevent a business from taking on unnecessary debt. Let’s explore a few different options.

Key Differences in Terms, Access, and Suitability

When should businesses use one type of loan over another? The right choice for your business depends on what kind of flexibility you want in disbursing funds and repayment, and how you prefer to manage costs.

  • Business Lines of Credit work somewhat like a credit card with a set limit. They allow businesses to draw funds up to that limit and pay interest only on the borrowed amount. This type might be good for companies with very flexible revenue streams or uneven business cycles.
  • Short-term loans offer a lump sum paid over a set term, usually a few months rather than years. These might be helpful if the need is clear and known ahead of time because they provide predictable installments. 
  • Merchant Cash Advances (MCAs) offer advances repaid through a percentage of daily credit/debit card sales. Lenders deduct repayments automatically from each sale. These might offer fast funds, but they’re often expensive.
  • Invoice Financing or Factoring allows lenders to advance a business funds based on outstanding invoices, improving liquidity while waiting on payments. These loans may help if the revenue issue isn’t a lack of sales but rather slow payments. These may also be fast but expensive if used regularly, especially if customers are late to pay expected invoices.
  • SBA Loans are government-backed loans, often with attractive terms but may have longer approval timelines. While many SBA loans may have longer-term financing or expansion, some SBA products support short-term operational funding. 

If funding urgency is high, alternative lenders may be a quicker option, but if cost control matters most, SBA-backed or credit-union products may be the better fit.

Tips for Responsible Borrowing and Repayment 

Borrowing for short-term needs offers financial stability, but it may simply add more pressure if a business chooses the wrong type. It may work best if you put the same amount of planning into preparing for the loan and its repayment as you do into using the funds. Here are some tips to make sure that even though it’s short-term funding, it supports your long-term goals.

Building a Repayment Plan That Protects Cash Flow

These tips may help you to plan ahead and maximize the outcomes of borrowing for the short term.

Match repayment timing with income. Because these are short-term loans, being more certain about where the funding will come from and when may make it easier to repay them. If income doesn’t match your repayment timing, you might end up with even more stress and less capital.

  • Run cash flow scenarios before borrowing. A financial forecast for different scenarios may uncover possible options if income doesn’t appear when it should or if returns don’t arrive as fast as expected. It may also help you pivot if necessary to ensure you stay current on the loan repayment.
  • Limit borrowing to expenses that generate near-term returns. There may be other loan options if your goals are happening over years instead of months. A short-term loan may put more financial strain on a business if repayment needs to happen now, but revenue may not pick up until next year.
  • Track how loan funds are used. If there isn’t one specific funding need, money might disappear quickly. Tracking where the funds are used may provide a better foundation for strategic use and help ensure all funds are ultimately going towards a specific goal.
  • Avoid stacking short-term debt. If you find that another short-term loan looks necessary, you may want to stop to review what has changed in expected revenue or circumstances to avoid setting a pattern of taking on debt. 
  • Evaluate performance regularly. Looking at the outcomes of these funds on a set schedule might determine whether the loan is providing things like healthier cash flow, stronger sales, or smoother operations.

Each of these steps may provide a better understanding of the overall outcomes and effects of the debt and offer support for the next steps in the business.

Borrowing Strategically for the Short Term

A working capital loan may provide businesses with greater flexibility in their revenue options and smooth over any short-term dips in cash. Taking out these loans with a strategic eye might give businesses the financial flexibility to thrive amid unexpected obstacles or temporary periods of lean revenue.