Strong cash flow can support a business in everything from day-to-day operations to leveraging assets for future growth. However, maintaining a steady cash flow can prove challenging for many successful businesses, especially those in seasonal or cyclical industries. Working capital loans are short-term business financing solutions designed to cover day-to-day operating expenses such as payroll, rent, inventory, and other operating costs while helping businesses manage cash flow and pursue growth opportunities.

What is a working capital loan?

A working capital loan is a form of small business financing used to help companies manage short-term operational needs. Working capital is defined as the difference between a company’s current assets and current liabilities. 

Businesses use working capital loans to cover everyday expenses, including payroll, rent, inventory acquisition, and utilities. In addition, working capital loans can also be used to fuel growth. For example, if a company receives an offer that requires a significant upfront investment but promises long-term returns, a working capital loan can bridge the gap to make the opportunity viable.

How do working capital loans work?

Because working capital loans are intended to cover day-to-day operating expenses, they are short-term and typically repaid within two years or less. Short-term working capital financing may be approved more quickly than long-term or SBA-backed options, depending on documentation and underwriting requirements. While most working capital loans are unsecured, some financing structures may require collateral from businesses with less-than-stellar credit. Businesses looking to purchase or construct a building, obtain equipment, or achieve other long-term goals are better off exploring loan options that prioritize the long view.

Types of working capital loans

There are two main types of working capital loans: short-term loans from traditional lenders, such as banks and credit unions, and loans partially guaranteed by the Small Business Administration (SBA). Both types serve similar purposes but may require different application and approval processes. The right option depends on both personal finances and your business’s financial profile. 

Short-term business loans

Businesses that are approved for a short-term loan receive their funds in a lump sum. Loan terms typically last between three and 24 months. While loan amounts are often lower, interest rates tend to be higher.  

Most short-term business loans are also unsecured (though specifics can vary by lender). Businesses with less-than-stellar credit may find it easier to qualify for this type of loan than for an SBA-backed loan.

SBA Loans

The SBA partially guarantees these short-term business loans, which helps SBA-approved lenders offer more favorable terms, such as competitive interest rates. However, the application process can prove challenging and time-consuming, and approval often depends on both personal and business credit. SBA-backed working capital loans provide structured repayment terms and competitive pricing for eligible businesses.SBA 7(a) loans can be used for working capital. CAP Lines are a type of 7(a) loan that offers a working capital line of credit. Businesses can also tap into express loans (another type of 7(a) loan with quicker approval times) and microloans, which are designed to help startups expand. 

Working capital loans: pros and cons

A working capital loan can provide the liquidity businesses need to cover their short-term expenses. However, these loans come with advantages and potential drawbacks that businesses should carefully consider.

Pros

• Easy to obtain
• Allows business owners to cover short-term working capital gaps
• A type of debt financing
• No equity transaction needed (owners maintain full ownership)
• No collateral required for unsecured loans
• Flexible use of funds
• Quick funding options 
• Accessible to a wide range of businesses 
• Easier eligibility than standard business loans 
• Allows deduction of interest paid on working capital loan 

Cons

• Unsecured working capital loans require a high credit rating
• Collateral is at risk if the loan is not repaid 
• High interest rates
• Borrower’s personal and business credit is at risk 
• Some lenders require daily or weekly payments 
• Shorter repayment terms 
• Lower loan amounts 
• Some lenders charge interest as a factor rate, which can make comparisons difficult

How to obtain a working capital loan

Most businesses can benefit from a working capital loan, but determining exactly how to use the funds—and how much is needed—requires careful planning. As you evaluate your business and its future, consult your business plan for guidance. Here are the basic steps to acquire a working capital loan: 

1. Evaluate your cash flow needs:
   Determine how much it costs to operate your business monthly and whether the business would benefit from a one-time cash infusion or a revolving line of credit.
2. Diagnose your company’s financial health:
   Assemble an overview of your company’s financials, from business and personal credit history to time in business, annual revenue, and assets that could be used as potential collateral. 
3. Seek out and compare lenders:
   Compare financing options based on interest rates, terms, additional fees, loan amounts, time to fund, and customer support to locate the best loan package for your business. 
4. Prepare your application:
   Gather important documents like your business plan, bank statements, tax return, and licensing that may be required for your application. 
5. Submit and track your application:
   Respond promptly to any additional requests for information and await approval. 

Alternative working capital funding sources

A business line of credit, merchant services, invoice financing, and inventory financing can also help companies fund daily operations and support growth, even though they’re not technically loans.

Business line of credit

A business line of credit is similar to a personal line of credit but is only used for business expenses. While it offers flexibility, letting you draw only what you need or can afford, its variable interest rates and maintenance or draw fees can increase repayment costs.

Merchant services

Through merchant services, you can secure a working capital loan based on your sales, while repaying it with daily or weekly revenue according to the lender’s terms. However, these loans often come with significant fees and stricter terms. 

Invoice factoring

With invoice factoring, you collateralize outstanding invoices to obtain a percentage of the value upfront. Once your customer pays, any fees owed are paid from the remaining balance. This option works best for businesses engaged in business-to-business (B2B) commerce. 

Inventory financing

Inventory financing lets you leverage your inventory to secure short-term working capital. Loan amounts, interest rates, and terms vary by lender. 

Is a working capital loan right for your business?

Don’t let short-term cash flow challenges hold your business back. Explore flexible working capital loan options with a Popular Bank’s business lending specialist and discover financing solutions that help your business stay agile and grow with confidence.