A working capital loan’s function is to fund a business’s day-to-day operations, such as sales and marketing, product development, payroll, and other expenses. A single lump sum is deposited into the borrower’s account and repayment begins immediately.

A working capital loan is a debt payment that allows a company to meet short-term financial needs to continue operating aside from traditional loans. The difference between your company’s current assets and current liabilities is its working capital, commonly called net working capital. This sort of financing is widespread among small and medium-sized businesses that might need a loan roughly equivalent to one or two months’ deposit totals.

Most working capital loans are for six to twelve months and have competitive rates of interest ranging from 11 to 40 percent, depending on a variety of criteria regarding the personal credit score and other factors.

Other Types Of Capital

• Debt

Borrowing from financial institutions, banks, friends and family, credit cards, federal lending programs, and venture capital, as well as issuing bonds, are all ways to obtain debt capital. Businesses, like individuals, require a credit history to borrow.

The loan term of any debt capital is that it must be paid back regularly (with interest). Still, unlike personal loans, it is considered a necessary aspect of the business’s growth rather than a financial burden.

• Equity

Any capital raised through the sale of shares is referred to as equity capital, with the fundamental distinction being whether the shares are sold privately or publicly:

Private: Stock in a corporation held by a small group of investors.

Public: Shares of a company’s equity listed on a stock exchange (think: IPO).

The money an investor spends on the stock in a company becomes the company’s equity capital.

• Trading Capital

Trading capital is only used in the financial industry, where brokerage firms require sufficient funds to carry out their investing strategy. The many daily trades that brokerage businesses must execute to make a profit and the large-scale deals done by the largest brokerage firms rely on trading capital. It is sometimes given to individual traders and other times to the entire company.

How Do Working Capital Loans Work?

At its most basic level, working capital financing is used to ease a short term need. You will receive a lump sum deposit and be aware from the onset of the total cost involved. You will use an agreed daily/weekly/monthly repayment amount that will automatically be debited from your business bank account.

Unlike most business funding or loans that finance various business activities, working capital loans are accepted and repaid in a short period of time—monthly payments— eliminating the risk of bad debt.

Other Types of Loans

Working capital, or the gap between a company’s assets and liabilities, is a metric that evaluates a company’s ability to generate cash to meet short-term financial obligations, also known as liquidity. The difference between existing assets and current liabilities is known as working capital. Here are some examples of the types of working capital or loan programs:

• Short Term Loan

This sort of financing usually has a defined term of six to twelve months and a fixed interest rate. With minimal documentation, zero collateral, and minimum verification, a borrower with a decent credit score can quickly receive this type of loan. This loan form is ideal for a business that needs money fast and has a strong credit score.

• Merchant Cash Advance

Small businesses can use merchant cash advances (MCA) as an alternative to conventional forms of funding, such as traditional bank loans. A merchant cash advance provider gives business owners a large sum of money upfront and requires them to return the advance with a percentage of their sales. Businesses with a high number of credit card sales need cash rapidly, and they might not qualify for a standard loan, meaning they may benefit from Merchant Cash Advances.

• Working Capital Line of Credit

As an additional working capital requirement can arise at any time, this line of credit allows you to fulfill last-minute funding needs conveniently. This feature is especially beneficial and affordable because it requires you to pay interest only on the amount you borrow from the entire sanctioned amount. Thus, similar to a bank overdraft facility, it offers several advantages over conventional modes of financing.

Business Financing Options

Are you seeking financing to operate or expand your small business and wondering where to turn to for a small business loan? As a small business owner, you now have more financing options than ever before—thanks to a number of creative web-based businesses offering new alternatives such as crowdfunding and peer-to-peer lending. Banks? They are just the beginning.

Read Also: How to Calculate and Interpret Working Capital Ratios for Your Business

Here’s our updated guide to 10 business financing options you should know about as you seek funding for your small business.

1. Bank loans and SBA Loans

The first type of business financing that usually comes to mind when you hear the term ‘small business loan’ is a traditional bank loan. Bank loans come in many forms (short-term, long-term) and can be used for a wide variety of purposes (working capital, expansion, equipment purchasing, commercial real estate). Sometimes these loans are secured with collateral; sometimes not. The most important things to know about small business bank loans? You are going to need to demonstrate stability (in the form of revenue, for example).

As for the best place to get a bank loan, well, that depends on your business needs—each bank has its own set of offerings and requirements. Regardless of where you go for a loan though, you are likely to encounter the option to apply for a Small Business Administration (SBA) loan. A popular subtype of bank loans, a large portion of each SBA loan is guaranteed by the SBA, a government agency that provides information and resources to entrepreneurs to help them develop strong businesses.

This SBA guarantee makes the idea of lending to small business owners more appealing to some banks, but the loans can be difficult to get because of the stringent requirements (in order to qualify for an SBA loan, you need to have a decent credit score, measurable cash flow and a solid business plan, among other qualifications). Despite that, SBA loans are attractive to many small business owners because they offer a lot of options and flexibility in terms of how the funds can be used. What’s more, the SBA also offers a variety of loan options for minority business owners and those that operate in underserved markets.

2. Credit card financing

If you need to purchase equipment or materials for your small business, credit cards—or, in a crunch, credit card cash advances—are easily accessible options that save you the trouble of applying for some other type of small business loan. Credit card financing, however, can be risky and you should strongly consider only using it for short-term needs. If you go this route, consider paying off the card in time to avoid hefty finance charges, and look for cards that offer cash-back rewards or airline miles.

3. Business line of credit

A business line of credit gives you access to a certain amount of capital to use as needed, typically based on your business’s cash flow and credit score (a business line of credit functions more like a credit card than a small business loan, but they are not one in the same). You don’t have to tap into the line of credit until you actually need the funds, and you won’t accrue interest on funds you aren’t accessing either.

Once you borrow from it, though, you will need to start making payments on the amount you used right away. As you pay back the actual funds borrowed, your line of credit will gradually replenish (meaning you once again have access to the money).

4. Equipment financing

Some lending companies specialize in financing the purchase of business equipment. Another option? Ask the company you’re buying the equipment about financing—many offer their own financing programs.

5. Merchant Cash Advance (MCA)

In this type of financing, you get a lump sum advanced in anticipation of future credit card sales. Daily payments are made automatically by ACH transfer and are typically based on a percentage of that day’s credit card transactions—so on a day when you make less, you pay less.

6. Invoice Factoring

Factoring is a system where you sell your outstanding invoices to a third party ‘factoring’ company at a discount (typically, around 80 percent of the value of the invoices). The factoring company then takes over the job of collecting payment on those outstanding invoices from customers on your behalf (they return the 80 percent to you and keep the rest as their fee).

Factoring can be helpful to small businesses that operate on a net 30 to net 90 payment system because it allows the businesses to get paid immediately rather than waiting until payment is officially due. The main downside to invoice factoring? You don’t receive your full payment. However, it can help alleviate cash flow concerns in some cases.

7. Invoice Financing

This is one of the small business financing solutions we offer at Fundbox. Similar to factoring, invoice financing can help improve your cash flow by allowing you to borrow against your outstanding invoices so you don’t have to wait to get paid on a product you already delivered or a service you already provided. However, unlike factoring solutions, invoice financing through Fundbox can enable you to access 100 percent of your invoice value, up to your approved credit limit. Plus, you maintain your relationship with your customers.

8. Purchase order financing

With purchase order financing, a lender provides the funds to buy inventory or materials to a small business that doesn’t have the cash on hand to fulfill a large order. After the order ships, the lender collects payment from the customer, subtracts fees and transfers the balance of the invoice back to the business at hand. Be aware that purchase order loans don’t apply to would-be orders—you need to have actual orders on the books in order to qualify.

9. Peer-to-peer loans

Peer-to-peer lending sites are online marketplaces where businesses and individuals can obtain loans from individual investors. The online marketplace manages the transaction, serving as a kind of escrow service, and takes a fee in return. This can be a good way to get a small, short-term loan if other methods haven’t worked.

10. Crowdfunding

A variation of peer-to-peer lending, crowdfunding sites allow businesses to pitch their ideas (often new inventions or products) and seek financing from interested individuals. The difference is that the money isn’t a loan, but a payment in return for something from your business, most often in the form of equity in your company to these early investors, or even something as simple as early access to your product or service.

If your idea sparks the public’s interest, it’s possible (though not probable) to raise hundreds of thousands of dollars through crowdfunding. And even though it sounds like a long shot, it could be an option for some small businesses to consider because the crowdfunding market is expected to grow to nearly $200 billion by 2025.

What are the Ways Used to Finance Working Capital?

Although big banks approved a record number of small business loan applications last year (25.4 percent), and smaller banks approved about 49 percent of small business loan applications, that still leaves a significant share of small businesses that can’t get loans.

One problem is that the majority of small businesses seeking loans need $50,000 or less. Since it costs a bank the same amount of money to process a $50,000 loan as a $1 million loan, but with much less profit, there’s less incentive for banks to lend the small amounts that small businesses need.

The good news: Bank loans are far from the only source of working capital financing. Here are six other ways you can get the money you need.

1. Trade credit/vendor credit

You may already be using this type of financing. If you ever purchase inventory or supplies net 30, net 60 or net 90 days, that’s an example of trade credit. Getting a short grace period to pay your bills can make all the difference in your cash flow. You may even be able to find vendors who will let you maintain a balance, instead of paying your bill in full each month.

Another option is for you and your vendors to use Fundbox Pay. When you make purchases through Fundbox Pay, your participating suppliers get paid immediately—and you get 60 days (or more) to pay.

2. Business credit cards

When you need money quickly, the answer to your problems could be right in your wallet. The Small Business Administration reports that credit cards are one of the top three sources small businesses use for short-term financing. If you already have a business credit card, there’s no need to apply or wait for approval, plus you have the option of financing a purchase with your credit card or taking a cash advance.

Of course, with business credit cards charging interest rates that average 14.16 percent, this can quickly become a costly financing method — especially if you miss a payment or can’t pay the minimum.

3. Business line of credit

If you can qualify for one, a business line of credit offers lots of advantages as a source of working capital. It’s unsecured, which means you don’t have to put up any collateral. What’s more, you don’t have to repay any money until you actually draw on the line of credit. In other words, if you get a line of credit for $25,000 in January and draw $15,000 to make payroll in June, you won’t have to start making payments until July.

As you pay back what you borrowed, the available amount of credit increases until it’s back where you started. There’s got to be a catch, right? There is: Your business will need a track record of success and an excellent credit score in order to qualify.

4. Merchant cash advance financing

Does your business make a lot of credit card sales? Then merchant cash advance (MCA) financing might work for you.

With this financing option, you take a cash advance against your business’s future credit card sales. The lender collects a percentage of your daily credit card sales until the advance and fees are paid off. No collateral is necessary, and on days when your credit card sales are low, your payment will be, too. However, fees for merchant cash advances can add up quickly.

5. Invoice factoring

A factoring company (also called a “factor”) purchases your business’s outstanding invoices for a percentage of their face value — typically about 70 percent to 85 percent. The factor then takes over collecting your invoices; when the factor collects, they give you the rest of the invoice’s face value, minus their fees. While it is a quick way to get money, you won’t get the full amount you’re owed. And since the factor takes over your collections, this can cause confusion for your customers.

7. Invoice financing

Although it may sound similar to factoring, invoice financing has a couple of important advantages. If you choose to finance invoices with Fundbox, you get the full value of your invoices, minus a flat fee. With invoice financing, you continue to oversee collections on the invoices, so you stay in control, and your customers never know you used an invoice financing company. If approved, you get the money right away and pay it back over 12 months, which gives you plenty of time to get paid for the invoices.

Finally

While there are many options out there, choosing the right one for you depends on your business, your timeline, and your financial situation. Often, the right choice is actually to work with several financing options, using a different one for different needs.