A Business Owner’s Guide to Understanding Working Capital Loan Interest Rates

As a small business owner, it’s important to be able to cover short-term business expenses and debts. Since revenues aren’t 100% predictable, you need to have a cash flow cushion to withstand unexpected events. The amount you need to operate and withstand these unexpected events is called working capital. 

Sometimes, your working capital runs low. That’s when business working capital loans can come in handy. The best working capital loans offer short-term solutions for business needs like seasonal dips, economic downturns, or emergencies like a piece of manufacturing equipment breaking down. Understanding working capital loan rates will help your business stay prepared in the event that it needs an influx business financing.

In this article, you will learn:

• What working capital is
• Ideal amount of working capital for your small business
• Types of working capital loans and apples-to-apples comparisons of working capital loan interest rates

What is Working Capital?

Working capital is your current assets minus your current liabilities. Current assets are any assets on your balance sheet that are expected to be sold or used over the next year. They include: 

• Cash or cash equivalents 
• Accounts receivable 
• Prepaid expenses 
• Inventory

Current liabilities are liabilities that are due over the next year. They include:

• Accounts payable
• Notes payable 
• Taxes payable 
• Dividends 

You have positive working capital if your current assets are greater than your current liabilities. You have negative working capital if your current assets are less than your current liabilities.

What is the Ideal Amount of Working Capital for Your Small Business?

There is no single ideal amount of working capital for your small business – it depends on a few variables:

• What is your type of business? Do you have a seasonal business that is growing rapidly or a mature business with steady quarterly revenue? The former will require more working capital to provide a cash flow cushion during quarters with low sales and fund long-term growth. 
• When do you bill customers? Let’s say you have a services business, and it takes two months to render services to the average customer and longer for payments to hit your business bank account. Your working capital needs will be heavily impacted by when you bill your customers (half upfront and half upon completion, all upfront and all upon completion, etc.).
• What is your projected operating cash flow? A startup that is expecting to triple its operating cash flow over the next year may be able to withstand slightly negative working capital. But an established business that is expecting operating cash flow to be flat over the next year shouldn’t have negative working capital, in most cases.
• How much do you have in current liabilities? For a company with $20,000 in current liabilities, $40,000 in working capital is likely to provide a nice cushion for unexpected events. But $40,000 in working capital may not be enough for a company with $1 million in current liabilities. The first company has 3x as many current assets as current liabilities, while the second company has 4% more current assets than current liabilities. It’s all relative.

Working capital ratio (current assets/current liabilities) is an excellent starting point to find the ideal amount of working capital for your small business. Most analysts consider the ideal working capital ratio to be between 1.5 and 2. Short-term loans, provided they have good working capital loan rates, can help you maintain a strong working capital ratio.

Types of Working Capital Loans

There are several working capital financing options for small business owners. Some loans have an explicitly stated working capital loan interest rate for monthly payments. Others calculate repayment based on fees or a factor rate – while there isn’t a specific interest rate, it’s possible to calculate an equivalent interest rate. 

In this section, we provide apples-to-apples comparisons of working capital financing options to examine how explicit interest rates stack up against equivalent interest rates. Here are some of the best working capital loans: 

You may also like: revenue based financing rates, small business working capital 

SBA Loans 

The U.S. Small Business Administration (SBA) 7(a) loan program provides small business owners with a maximum loan amount of $5 million. The money can be used for a variety of purposes, including working capital needs. The SBA guarantees the majority of the loan, reducing the risk of the lender – this allows the lender to offer a lower interest rate to borrowers. This rate varies depending on the loan amount and whether it is a fixed or variable rate loan. 

The low interest rate available via an SBA loan makes it an attractive option for small business owners, but strict eligibility requirements and a lengthy loan application process make it tough to use an SBA loan for short-term working capital needs in many cases. 

The SBA recently began a Working Capital Pilot program within the SBA 7(a) umbrella. With competitive working capital loan rates and fast funding available, it’s a good option for small business owners who meet the minimum credit score requirement of 650 or more. 

Term Loans 

A term loan provides the borrower with upfront cash from a bank or credit union to be repaid on a set schedule at a variable or fixed interest rate. The specifics of a term loan vary depending on the lender, and there’s no single best bank for working capital loans. Term loans may require a personal guarantee or collateral to secure the loan, making them riskier to borrowers. 

In many cases, an online lender like Biz2Credit may make more sense for small business owners looking to cover day-to-day activities like operational expenses and shore up working capital. (Especially if their creditworthiness is suspect.) 

Strong applicants may be able to get attractive working capital loan rates from a traditional bank loan, but online lenders provide additional options, often with fast funding times as short as a single business day. 

Business Credit Card 

A business credit card works like a personal credit card, with one key difference: it’s connected to your business instead of your personal expenses. Since working capital needs are often short-term and unpredictable, a business credit card is a great way to address those needs in many cases. 

While many business credit cards have double-digit interest rates, you may be able to find a credit card with a 0% APR introductory period for between 6 and 18 months. 

Business Line of Credit 

A business line of credit is like a combination of a business loan and a business credit card. You can borrow what you need, and you only pay interest on the amounts borrowed. 

With many online lenders, you need a 580+ credit score, 12 months in business, and $10,000 in average monthly revenue to qualify for a business line of credit. So, the bar is not too high for a business line of credit. Some providers, like American Express, may have no minimum annual revenue requirement. 

The average interest rate is between 7% and 25%, which may be high compared to other working capital loan rates. In addition, the interest rate is variable in many cases – so you may not know your interest rate ahead of time. The good news is that you’re under no obligation to use a business line of credit if the interest rate is higher than you expected. 

Merchant Cash Advance 

A merchant cash advance (MCA) is a small business financing option that provides small business owners with a lump sum payment to be repaid through a percentage of future sales. With an MCA, the amount to be repaid is based on a factor rate, not an interest rate.  

The factor rate, which is typically somewhere between 1.2 and 1.5, is multiplied by the amount borrowed – and that number is the total amount to be repaid. So, if you borrow $100,000 with a factor rate of 1.3, the total amount to be repaid is $130,000. 

The repayment period for a merchant cash advance is often a year or less, so the equivalent interest rate can be high double-digits – or even low triple-digits. The good news is that a merchant cash advance is attainable for small business owners with bad credit scores, as they often require a minimum credit score of 525-550. 

Invoice Financing 

With invoice financing, you borrow money against unpaid invoices. An invoice financing company typically charges a flat percentage (1-5%) of the invoice value in exchange for providing the money upfront. It doesn’t sound like much, but the equivalent annualized interest rate is very high if you get charged 2% of the invoice value, and it only takes 2 weeks for the client to pay the invoice. 

You may be able to qualify for invoice financing if you have a startup or bad credit, and if you use it to satisfy very short-term working capital needs once in a blue moon, the high “interest” won’t matter much in the grand scheme of things. 

Invoice Factoring 

Invoice factoring provides small business owners with a lump sum of cash in exchange for their outstanding invoices. With invoice factoring, you sell the invoices to the company – you get the value of the invoices minus a factoring fee (typically between 1-5%). In many cases, the company pays you 85% of the amount upfront and pays you the rest of the money (minus fees) after the invoice is collected. 

It’s not too hard to qualify for invoice factoring, but as with merchant cash advances and invoice financing, the “interest” is usually higher. 

The Bottom Line

Your working capital needs are likely to be short-term, so it’s easy to overlook the interest rate being paid on borrowed funds. However, the interest rate on some types of working capital funding solutions may be very high. You also may have to secure working capital financing repeatedly. 

The right type of working capital financing depends on your small business’s situation and current business needs. In any case, you don’t want to wait long to get working capital funding. With Biz2Credit, you can get competitive working capital loan rates and receive funding in as little as 72 hours. 

Navneet Kalra, the President of Perfume Store Inc., wanted to secure inventory financing so he could satisfy sky-high holiday season demand. With Biz2Credit, he got an offer by the next day, and said, “I’ll give Biz2Credit a 10 out of 10. The whole team I worked with did an excellent job – they understood my business and everyone from my case manager to the underwriters were very friendly and communicative.” 

Learn more about how Biz2Credit can help your small business get working capital financing. 

FAQs

1. What is working capital?

   Working capital is the amount of cash flow you need to cover operational costs and create a cash flow cushion to help navigate unexpected business challenges.

2. What is a working capital loan?

   A working capital loan is a short-term funding solution that helps a small business get a cash flow infusion to cover a variety of business needs.

3. What types of loans are working capital loans?

   Many loan types are available as working capital loans. There are SBA loans available, as well as term loans from banks, credit unions, and online lenders. There are also many short-term working capital loan options, like business lines of credit, invoice financing, merchant cash advances (MCAs), or even equipment financing.

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