What You Need to Know About Working Capital Loans

Julia CalifanoUpdated May 22, 2023

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Editor’s note: Lantern by SoFi seeks to provide content that is objective, independent and accurate. Writers are separate from our business operation and do not receive direct compensation from advertisers or partners. Read more about our Editorial Guidelines and How We Make Money.

Working capital is a term commonly used to define how much liquid cash a small business has available for expenses like operational costs, payroll, and inventory. It’s technically defined as the difference between the business’s assets and its debts or accounts payable. When a business has enough cash to cover its operating expenses and invest in future growth, it has positive working capital. When it doesn’t have enough cash, it has negative working capital and may want to seek out working capital loans. There are numerous kinds of small business working capital loans available, depending on what kind of business it is and what its unique needs are. To ensure that you get funding that aligns with your small business, it’s helpful to understand how each loan product differs.The following guide will break down what you need to know about:

Different types of working capital loans
How to apply for them
Alternative lending options

But first, let’s get into what working capital loans are and why you might apply for one.

What Are Working Capital Loans?

If a small business has negative working capital or anticipates cash fluctuations, it may want to consider a working capital loan. This type of loan (also known as a business capital loan) offers businesses short-term financing to cover expenses like:

Monthly bills and/or debt payments
Payroll
Inventory
Operational expenses
Emergency expenses

Unlike commercial real estate loans, working capital loans aren’t intended for long-term investments or big purchases. There’s a lot of variety in this category of loan. Since working capital loans are typically smaller loans, there are many different types of lenders who offer different kinds of financing, from working capital lines of credit to invoice factoring. Banks, credit unions, online lenders, peer-to-peer (P2P) lenders, and alternative lenders are all potential sources of capital loans. Each has varying eligibility requirements and business loan terms.

Who Might Want a Working Capital Loan?

Small business owners may measure their working capital to assess their overall financial picture, to evaluate operational efficiency, and/or to prepare accurately for future expenses and/or seasonality. If a small business has significant assets compared to its liabilities and also boasts a predictable cash flow, it might not require a working capital loan. Unfortunately, however, many small businesses don’t have predictable cash flow or sufficient assets and thus have negative working capital. This situation can be the result of seasonality, sales cycles, holidays, or fluctuations in the economy, and it’s especially common for startups or less-established small businesses. Without reliable revenue, these businesses may turn to working capital loans. Some common businesses that may rely on capital loans include:

Restaurants
Manufacturers with cyclical sales
Retailers with seasonal business
Building contractors
Startups
Businesses looking to expand

How to Calculate Working Capital

Working capital can actually be quantified. To calculate your business’s working capital, you’ll need to identify your current assets and current liabilities. Current assets are things that currently belong to your business and could easily be converted to cash within a year or business cycle (whichever is shorter). Examples of business capital assets may include:

Cash (checking and savings accounts)
Accounts receivable
Inventory
Assets soon to be paid off or liquidated (like equipment)
Stocks, bonds, and mutual funds

Current liabilities are items you’ll need to pay within the following year or business cycle. These could include:

Rent
Utilities
Supplies
Principal and interest payments on any debt
Accounts payable
Accrued taxes
Long-term debt that will be due in the short-term

After adding up your current assets and liabilities, you can calculate working capital using the following formula:CURRENT ASSETS – CURRENT LIABILITIES = WORKING CAPITALFor example, if your business has $200,000 in current assets (property, cash, inventory, etc.), and $75,000 in current liabilities (rent, debt payments, taxes, payroll), your positive working capital is $125,000.$200,000 – $75,000 = $125,000Conversely, if your business has $100,000 in current assets, but $150,000 in current liabilities, you would have -$50,000 in negative working capital.$100,000 – $150,000 = - $50,000Positive working capital is a sign of good business health. It's usually an indicator that you’re in a good place to expand. Negative working capital can indicate financial troubles, which could ultimately lead to your defaulting on debt payments or entering bankruptcy.

Pros and Cons of Working Capital Loans

Working capital loans for small businesses are typically smaller loans and are available from a variety of lenders. These factors make these loans accessible to a number of different types of businesses, from startups to well-established organizations.The pros of working capital loans may include the following. Working capital loans:

May not require collateral (these are called unsecured loans)
Can help improve cash flow
Let you maintain ownership of your business (they don’t involve private investors)
May involve a faster loan process than other products
Offer spending flexibility with few restrictions from lenders
Come in numerous types of loan products

Like any loan product, working capital loans may come with potential negatives you should be aware of. A few potential cons include:

Unsecured working capital loans may require a higher credit rating
Some working capital loans may have higher interest rates than other loans
Working capital loans may affect your personal as well as your business credit

Types of Working Capital Loans

If business fluctuates and you need extra cash to infuse your monthly budget, working capital loans can help. There are a number of different loan products that offer short-term solutions, but keep in mind that not all will be suitable for every business.Use the quick guide below to learn more about working capital loan products and help you assess which one is right for your business.

SBA 7(a) and 7(a) Express Loans

What it is: Both SBA 7(a) and SBA 7(a) Express loans are offered through approved SBA lenders like banks and certain online lenders. These SBA loans give small business owners flexibility to use funds for a variety of working capital expenses. The SBA Express program has a faster turnaround time for review, with responses typically within 36 hours of application, and a maximum loan amount of $500,000. In contrast, the standard 7(a) loan has a maximum amount of $5 million but may take longer for application review. Why choose it: SBA-backed financing provides access to low-interest working capital loans for small businesses, ideal for covering short-term or long-term expenses. Additionally, small loans of $25,000 or less don’t require collateral.Keep in mind: Lenders may have different eligibility requirements, depending on the loan amount, business’s industry, and the lender itself. Typically, SBA loans are relatively difficult to qualify for. It’s important to have good credit, proof of your business’s revenues, and a business plan ready to present to your lender.

Short-Term Loans

What it is: Short-term business loans are commonly used to secure working capital. With one of these loans, you receive a sum of money upfront and pay it back with interest over a set amount of time. Short-term loans typically have terms of 18 months or less. Why choose it: If you need cash fast and can repay the loan fairly quickly, a short-term loan may be a good choice. Because they’re less risky for lenders, short-term working capital loans may also be easier to obtain for a borrower with low credit or a less-established business. Keep in mind: Short-term loan products typically have higher interest rates and lower borrowing amount limits than other term loan products.

Lines of Credit

What it is: A business line of credit is a common short-term working capital loan option that helps small businesses manage cash flow and cover small expenses. Borrowers receive a set credit limit from the lender to borrow against. Interest is charged only on the money withdrawn. Lines of credit are often revolving, though some end when the balance is paid off.Why choose it: If your business experiences seasonal fluctuations, sales cycles, or has emergency expenses, a business line of credit can be helpful to supplement cash flow. It’s typically easier to qualify for business lines of credit because the funding amounts are generally small and the debt is short-term. Keep in mind: Starting a business line of credit may involve additional fees and costs. The borrowing limits are typically lower than they would be for a long-term loan.

Invoice Factoring

What it is: Invoice factoring is when a business sells its unpaid invoices to a factoring company at a discount in return for cash to cover working capital expenses. Since the factoring company now owns the invoices, it collects payment directly from your customers rather than you being responsible for collections. Why choose it: Businesses that offer products and services and have irregular billing cycles can use invoice factoring to help cover operating expenses rather than just waiting for customers to pay. A factoring company offers the small business a percentage of the value of its outstanding invoice amounts upfront. That sum can then be used to reinvest in the business or pay small monthly expenses, for example. Keep in mind: Since lenders take on more risk with invoice factoring, the costs can be high, including numerous fees and high APRs triggered if the clients’ payments are late. The small business also loses control over the collections, so it’s important to confirm that your factoring company follows ethical collection processes.

Inventory Financing

What it is: Inventory financing is a type of short-term working capital loan that provides funds to buy inventory and then uses the inventory you buy as collateral for that loan. Why choose it: Inventory financing can be helpful for retailers who deal with cash flow fluctuations due to seasonality or revolving inventory. It allows businesses to pay for products upfront in anticipation of seasonal sales highs.Keep in mind: A number of factors that can affect the amount of financing and interest rate you’re offered. For instance, since inventory depreciates over time, you may not receive a loan that reflects the full value of the inventory’s original purchase price.

Merchant Cash Advances

What it is: A merchant cash advance offers a business cash upfront in return for repayment that’s taken as a percentage of the borrower's future credit card sales. Typically, automatic withdrawals are taken directly from your bank account on a daily or weekly basis.Why choose it: Merchant cash advances may provide a quick way to access cash for a variety of business expenses. If you have bad credit or a newly established business and don’t have other capital loan options, merchant cash advances can help. Keep in mind: This type of business capital loan presents more risk to the lender and thus can be expensive. Borrowers will pay more for the convenience of accessing cash quickly this way.

Bank Overdraft Facility

What it is: When a business needs working capital, establishing a bank overdraft facility with a bank can give it access to cash even if its bank account is empty or overdrawn. In other words, the bank agrees to keep processing payments for a certain length of time while the business’s account balance is zero or less. Why choose it: For a small business that doesn’t have consistent cash flow or positive working capital, this can provide a backup plan to ensure that the bank continues processing payments until additional funds are received. Keep in mind: Interest is charged on the loan and there may be additional fees when an overdraft occurs.

How to Apply for a Working Capital Loan

The process for getting a working capital loan for your small business will depend on the type of loan product and lender. In general, though, the following steps will help you find, apply for, and obtain a loan for business capital.

1. Determine What the Loan Is for and How Much Capital You Need

While you may be seeking a loan for working capital, you still need to consider what exactly you will use the funds for. This will help you determine how much to ask for and which loan product is most suitable. Here are some factors to consider:

What type of working capital do you need to cover — payroll, inventory, bills?
How much money do you need?
How often will you be able to make payments?
What is your budget for payments?
Do you have other sources of funding?

2. Decide Which Type of Capital Loan Is Right for Your Business

Based on the questions answered above, choose which type of capital loan aligns with your needs:

Short-term loan
Business line of credit
Invoice factoring
SBA loan
Merchant cash advance
Inventory financing
Bank overdraft facility

3. Assess What Your Business Probably Qualifies For

When choosing a loan and lender, check that your qualifications match the type of product you’d like to apply for. Consider:

Your personal and business credit rating
What, if any, collateral you can provide
State of your business finances
How long your business has been operating
Whether you have positive or negative working capital

4. Choose a Lender

Now that you have an idea of your qualifications as a borrower, you can start to narrow down what types of loans and lenders may give you the best chance for approval. Take the time to do your research and compare small business lenders that align with your needs and qualifications. Don’t forget to check what the lenders’ fees, interest rates, loan terms, and conditions are to assess the full cost of the loans. It’s helpful to get the full picture of your potential financial commitment before submitting your application.

5. Prepare Documentation and Submit Application

Before completing an application for a small business working capital loan, gather all the necessary documentation. This may include:

Business financial records
Personal and business credit reports
Cash flow projections
Your business plan (to show how the working capital loan will be used)
Identifying information, which may include proof of your citizenship
Business legal documents

6. Partner with a Lender to Secure a Capital Loan

After you’ve submitted your application, continue working with your lender to ensure that the process goes smoothly and you can receive funds in a timely manner. The process for short-term working capital loans is typically faster than for long-term loans, particularly if you decide to go through an alternative online lender.

Lenders Who Offer Working Capital Loans

Curious about lenders who offer working capital loans? Here is a sampling of recommended lenders based on a Google search of “best working capital loans” conducted on May 10, 2023. Rates will depend on loan amount, terms, and borrower qualifications.

Lender	Loan Amounts	Terms	Minimum Time in Business	Minimum Credit Score
OnDeck	$5,000 - $250,000	24 months	1 year	625
Bluevine	Credit lines up to $250,000	6 or 12 months	24 months	625
Fundbox	Credit lines up to $150,000	Not specified	6 months	600
Fora Financial	$5,000-$1.4 million	12 months-25 years	6 months	500
Funding Circle	Up to $500,000	6 months-7 years	2 years	660

Alternatives to Working Capital Loans

If you’re looking for additional financing for working capital or have long-term financing needs, the following types of loans may be helpful:

Restaurant Loans

Restaurant loans help with costs when you’re starting or expanding a restaurant business. Many different types of lenders offer restaurant loans including traditional banks, alternative lenders, and P2P lenders.

Franchise Financing

If you’re preparing to open a franchise, a franchising loan can help with the expenses. In addition to traditional lenders like banks, there are also franchise companies who specialize in offering loans specifically for franchise owners.

Equipment Financing

Equipment loans are useful for purchasing business equipment with a loan term that’s typically equal to the expected lifespan of the equipment. The equipment acts as collateral for the loan. Interest rates can vary, depending on the business’s industry, the type of equipment, and the borrower’s qualifications.

Personal Loans

If you don’t qualify for other types of business or working capital loans, you may want to consider a personal business loan. Not all lenders allow you to use a personal loan for business purposes but if you can find one that does, this type of loan can give you more flexibility than a strictly business loan.

Find Working Capital Loans with Lantern Credit

It can be overwhelming trying to figure out your best option for securing a working capital loan. We’re here to help you spend less time on the loan search and application process so you can spend more time growing your business. With Lantern by SoFi’s online debt financing marketplace, you can compare working capital loan options (including SBA loans, lines of credit, and short-term loans) without scouring the web and checking multiple sites. With one short application, you’ll be matched with a loan option that meets your company’s needs and qualifications.Let Lantern help you find the right financing solution for your small business.

Third-Party Brand Mentions: No brands or products mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

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About the Author

Julia Califano

Julia Califano is an award-winning journalist who covers small business, personal loans, credit cards, and other financial topics for Lantern. She has over 20 years of experience writing and editing articles on personal finance and other consumer topics for major print and digital outlets, including DailyWorth, Good Housekeeping, Glamour, Self, the Slingshot Fund, Harper’s Bazaar, and Fordham Lawyer Magazine. She has also served as an editor at Time Inc., Conde Nast, and Hearst.

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