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Alternative Finance blog

When is a working capital loan right for my business?

2 years ago

By Zaynab Ahmed, Marketing Manager, Spotcap UK


Despite being the backbone of the UK economy, many small and medium-sized businesses (SMEs) struggle to access the right funding once there is a sudden need to cover day-to-day expenses. There are many reasons for this - invoices not being paid on time, an increase of orders that requires more stock etc. The problem is that many business owners do not have the time to familiarise themselves with all the financing options available. And who can blame them if they also have to ensure that their clients are satisfied, orders are delivered on time and their staff is motivated?


Over the years, we have received a lot of questions from SMEs about working capital loans and realized that many businesses struggle to correctly understand the term: After all, it is a loan to cover working capital … or is it? There are a variety of different options available, and it is important to understand them to find funding that fits.


Why do businesses need a working capital loan?


A working capital loan aims to cover the day-to-day expenses of a company, such as accounts payable, wages or office costs. Especially those businesses which are affected by seasonal fluctuations rely on these loans as it helps them bridge periods of slower business activity. Working capital loans are usually short term and repaid by the time the business hit busy season or receives payments, and therefore no longer need the money.


What are the different types?


There are different kind of working capital loans available. For example, smaller businesses might use their bank overdraft or credit card. Others, generally larger companies, use invoice finance, where businesses can borrow money based on amounts due from customers; or a merchant cash advance, a regular small loan which is repaid by cash from future sales. And some business owners even borrow money with the help of a personal loan.


Taking out a fully unsecured working capital loan is another alternative. In this case, the business owner does not need to put down any collateral or a personal guarantee to secure the loan. It also means that the funding is not tied to any invoices or future income and therefore gives SMEs more flexibility. What’s more, if a business has already taken out a longer-term asset-based loan, an unsecured working capital loan can be complimentary as it holds no claim on any assets.


Working capital loans vs. Long-term loans


A typical working capital loan is designed to finance everyday working expenses in the short term as a business’ income can go up and down over a short period of time. In addition, the loan should be flexible – for example no penalty fee for early repayment – easy to set up, preferably within a few working days. This way, SMEs can take out a loan swiftly when required, but still keep their borrowing costs down. That said, businesses should note that a working capital loan is not suited to buy longer-term assets, such as machinery, or make a larger investment, as these normally require repayments over a longer time period.


For those small and medium-sized business owners who need access to a working capital loan swiftly, there are several options available to them. What’s more, securing flexible funding is important and it can be a great way to cover any gaps in working capital expenditure. Ultimately, this will help SMEs focus on what really matters – growing their business.

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