How to Get Working Capital as a Small Business

Every business needs working capital. A healthy amount of working capital enables a small business owner to meet their daily operational expenses and have some cash flow cushion in the event of a financial emergency or unexpected expenses. On the other hand, a lack of working capital threatens a small business's long-term health. Here, we’ll explore how to get working capital as a small business and break down the importance of small business working capital.

What is Working Capital?

Working capital is calculated by subtracting your current liabilities from your current assets. Your current assets are anything that can be turned into cash within the next 12 months, while your current liabilities are your short-term financial obligations that are due within the same period.

Current assets include:

• Cash or cash equivalents
• Accounts receivable
• Inventory
• Bank accounts

Current liabilities include:

• Accounts payable
• Interest payable
• Taxes owed within the next year

If your current assets are greater than your current liabilities, you have positive working capital. If your current liabilities exceed your current assets, you have negative working capital.

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How Much Working Capital Do You Need?

So, if your current assets equal your current liabilities, you must have good working capital, right? Not exactly.

Small business working capital should have significantly more assets than liabilities so that you have enough cash to cover any unexpected business needs. For instance, let’s say your working capital equals two weeks of business expenses, but two of your biggest buyers are three months late in paying for their orders. The combined amount is equal to one month of business expenses, and you don’t have enough cash to cover your operating expenses.

You need positive working capital to manage scenarios like this one. The ideal working capital ratio (current assets / current liabilities) is considered to be between 1.5 and 2. But that number can be a little higher or lower depending on your type of business and operating cycle.

Type of Business

Your working capital needs will be higher if your business has some or all of these characteristics: a lot of physical inventory, seasonal lulls, and high business growth. If your business has low physical inventory, steady revenue, and has matured, your working capital needs will be on the lower end.

Operating Cycle

Does your business bill customers upfront or after services have been rendered? If it’s the latter, you will need more working capital. The amount of time it takes for your business to create and sell a product also impacts your ideal working capital ratio (the longer it takes, the more working capital you need). Some working capital financing is designed to address these specific needs.

How Do You Get Working Capital?

There are many ways to get working capital. While some entrepreneurs look to conventional term loans, U.S. Small Business Administration (SBA) loans, or personal savings, there are better loan options.

The drawbacks of traditional loans is that you’ll often need a high credit score and a minimum loan amount that may exceed your actual working capital needs. Not to mention, long-term loans come with monthly payments that may hold down your business. SBA loans may offer more flexible capital loans for business, but funding times tend to be slow and eligibility requirements are strict. Mixing personal assets with business assets is always risky from an accounting and compliance standpoint.

Here are eight alternative small business financing options that can provide fast working capital for a small business owner:

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1. SBA Lines of Credit

SBA loan products are not known for being speedy, exactly, but the organization does offer several types of working capital loans that we’d be remiss not to mention. The SBA offers both the CAPLines program, with different lines of credit catered to several types of business. As of August 2024, it also offers a Working Capital Pilot program that provides small businesses with working capital lines of credit within the popular SBA 7(a) loan program.

CAPLines programs include:

• Seasonal CAPLine: For businesses that experience significant working capital increases during particular times of year.
• Contract CAPLine: For businesses that have additional working capital finance needs to serve a specific contract.
• Builders CAPLine: For construction and general contracting businesses that need working capital to build or acquire commercial property.
• Working CAPLine: More generic product that provides small business working capital for a variety of business needs.

Although the loan application may be involved and require information like bank statements, tax returns, and monthly revenue reports, SBA working capital lines of credit may be promising short-term business solutions.

2. Merchant Cash Advance

A merchant cash advance (MCA) gives a small business owner upfront cash in exchange for a portion of future sales. This financing option was originally designed for businesses that relied heavily on credit card and debit card sales but is now available to small business owners who rely on other payment methods.

An MCA can be structured based on a percentage of your actual sales or an estimate of your future sales. You can qualify for a merchant cash advance with a low credit score and without a long track record, but MCAs come with high annual percentage rates (APRs) – sometimes in the triple digits. This means that you should only consider a merchant cash advance to meet a short-term lack of working capital.

MCAs are not usually offered by traditional banks; instead they’re an option provided by online lenders.

3. Invoice Factoring

Do you have a large number of accounts receivable on your balance sheet? If so, you may have a strong working capital position – but you may be unable to meet your short-term financial obligations.

A possible solution is invoice factoring, a business financing option that lets you sell your accounts receivable to a factoring company at a discount for a lump sum of cash. You would lose out on some of your revenue, but the immediate cash could be a game-changer for your small business. The discount rate can be anywhere from 1% to 5%, depending on the amount, the creditworthiness of your customer, and the factoring company.

4. Business Credit Cards

A business credit card is a great resource for small business working capital that works just like a personal credit card. Let’s say you need to purchase more inventory for the busiest three months of your fiscal year. You find a credit card with a 0% APR introductory period of one year, and you are confident that you will be able to pay it back in full over the next six months. In this example, purchasing the inventory with a business credit card would be smart.

Just make sure you pay back the credit in a timely manner to avoid high interest rates and additional fees when they ramp back up after the introductory period.

5. Bank Overdraft Facility

Small business owners tend to avoid overdrafts. But you may be surprised to learn that you can arrange a bank overdraft facility with your bank, allowing you to draw beyond the amount of money that you have on deposit without incurring penalties. In this arrangement, you pay interest on the overdraft amount and don’t have to worry about your standing with your bank. It’s a good way to meet occasional working capital shortfalls, but you shouldn’t use this to take care of long-term working capital needs, as the interest payments can really add up over a long period of time.

Provided you give your bank notice, overdrafting can avoid the burden of a loan repayment plan.

6. Peer-to-Peer Loans

Peer-to-peer lending allows small business owners to connect with individual investors, removing a financial institution as the middleman. The modern peer-to-peer lending system is a relatively new financing option.

A borrower who is having trouble getting other types of financing due to a low credit score or short credit history may be able to get approved through a peer-to-peer marketplace. The appeal for lenders is that they can generate higher interest earnings relative to a checking or savings account. The interest rate on a peer-to-peer loan can vary dramatically – it depends on the creditworthiness of the borrower and the platform. But in some cases, you can secure attractive terms.

7. Equity-Based Crowdfunding

Let’s say you have a startup that seems risky; it has a good chance of being successful, but it may also fail. Lenders see the risk more than the potential reward because they’re only earning interest, not equity.

If you have a high-potential idea, you may want to consider equity crowdfunding for your small business working capital needs. The upside of the business idea could allow you to get financing without giving up a big chunk of your business. If you go with this option, carefully craft and review the terms of the agreement as this isn’t a standard funding option.

8. Business Line of Credit

A business line of credit is a flexible financing option that functions somewhere between a loan and a credit card. A lender approves a credit limit you can draw from, but you only pay interest on what you borrow. You typically won’t be asked to commit to how you will use the money, which is ideal for someone with possible working capital needs in the future.

Let’s say you have a sudden spike in demand, but you have traditionally offered your customers net 30 payment terms. You don’t have the cash flow to cover the operational costs. If you have a line of credit, you can immediately borrow the amount that you need and pay it back after your day-to-day operations have normalized.

A business line of credit is an excellent financing option, but there is typically a variable, not a fixed APR. This means you could be stuck paying a higher interest rate than anticipated.

Conclusion

Getting working capital financing is crucial if you do not have a healthy working capital ratio. As a small business owner, getting a working capital loan isn’t always easy – particularly if you have a new small business. Alternative financing options may provide better solutions.

Biz2Credit can help you meet your working capital needs with a simple and straightforward application process and approval process that allows you to get cash in as little as 72 hours.

FAQs

1. What is working capital?

   Working capital is the money your small business needs to cover operational costs as well as unexpected expenses or financial emergencies. You calculate working capital by subtracting current liabilities from current assets.

2. What is a small business working capital loan?

   When they’re short on working capital, small businesses can use loans to cover immediate expenses and repay a lender later. These short-term loans come in many varieties, from merchant cash advances (MCAs), invoice financing, and more. Business lines of credit, although not a loan, are a common form of working capital financing.

3. How do you get a working capital loan?

   There are many ways to get a working capital loan, depending on what type of financing you’re looking for. Traditional lenders like banks and credit unions may offer short-term loans, while alternative and online lenders may offer more flexible funding solutions like MCAs or invoice financing. The SBA also offers working capital lines of credit and many banks and credit card companies have business lines of credit available, too.

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