What Is a Working Capital Loan and How Is It Used?

Working capital loans are often used by businesses to cover their short-term capital needs. This may include paying regular operating expenses, such as payroll, utilities and supplies, or meeting unexpected needs that aren’t within the budget.

Working capital financing can come in the form of small-business loans or alternative forms of business funding.

What is a working capital loan?

A working capital loan is a form of financing used to supplement your business’s available cash to cover expenses or another short-term business need.

A business’s working capital is calculated by taking current assets (cash and other assets that can be quickly converted to cash) and subtracting the business’s current liabilities.

Business term loans and lines of credit are common types of working capital loans. However, alternative types of financing — such as credit cards, invoice financing and merchant cash advances — are often considered working capital loan options.

Traditional banks, lenders offering Small Business Administration loans, online lenders, specialty finance companies, community lenders and nonprofit organizations are some sources of working capital loans.

» MORE:Looking for a working capital loan? Check out the best options

How does a working capital loan work?

With a working capital loan, like other business loans, you apply for financing with a lender. You’ll need to meet requirements set by the lender that relate to time in business, credit worthiness, annual income and other factors.

Based on the type of loan you choose, you’ll receive funding as a lump sum of cash or have the option to withdraw funds as needed. Depending on the lender, the funds you’ve borrowed will require monthly, weekly or daily payments.

Some working capital loans are secured business loans, meaning the funding is backed up by collateral such as equipment or property. Working capital loans can also be unsecured business loans that don’t require collateral.

Types of working capital loans and financing options

Working capital financing comes in a variety of forms which are often classified as either installment or revolving loans. An installment loan offers a lump sum of cash, whereas a revolving loan has a set limit that can be withdrawn at the borrower’s discretion.

Here are some financing types for working capital:

How do businesses use working capital loans?

Working capital loans are used for a variety of purposes. They can provide funds for expenses related to utilities, payroll or supplies. They can also be used for larger purchases such as inventory, facility upgrades and new equipment and machinery.

Here are some situations where a business may use working capital financing to meet the need for additional capital.

Seasonal fluctuations in sales

Many businesses experience monthly fluctuations in sales and revenue. However, for seasonal businesses such as farmers markets, tax preparation and landscaping, changes in revenue can be extreme. A working capital loan can help these businesses maintain operations during the off-season when revenue is typically at the lowest point, or provide the funds needed to prepare for the upcoming peak season.

Unexpected business opportunity

Sometimes a business owner may be presented with an opportunity that is unexpected. This might include expanding operations, onboarding a new client or accepting a large purchase order. When these opportunities come with additional expenses, a working capital loan can add money to the budget that can be used to hire staff, order inventory or purchase equipment.

Accounts receivable payment delays

Some businesses allow customers to buy their products and services on credit, instead of requiring payment at the time of purchase. Depending on the length of time given to the customer for payment, the cash flow of the business may be adversely affected. A working capital loan can provide the necessary funds for daily operations until payments are received.

Unbudgeted expenses

An emergency fund can help a business pay for unexpected expenses due to natural disasters, business closure or some other disruption to operations. However, if a business doesn’t have an emergency fund or the amount put aside is not adequate, a working capital loan can provide the needed capital. Funds can pay for repairs or the replacement of equipment, as well as supplement revenue to cover day-to-day expenses.