Working capital financing involves borrowing money to finance the day-to-day operations of your online business rather than purchasing long-term assets or investments.
In other words, you might take out a working capital loan to pay rent and wages or buy inventory rather than purchasing office space or equipment for your business.
This type of financing is especially common in industries with inconsistent cash flow. However, a working capital loan can also finance business growth or expansion, such as opening a branch in a new region. The loan can help fund operations until the new branch becomes financially self-sufficient.
What is Working Capital Financing?
Working capital financing refers to short-term loans and lines of credit online businesses can use to fund their daily operations and maintain liquidity. Banks, credit unions, and online lenders regularly give out these financial products to small business owners. Here are three important features of working capital loans:
Expenditure Gaps
When a business is growing, there may be some gaps between capital inflows and outflows due to late payments, emergency expenditures, and other unforeseen factors. During such times, you can use working capital financing to bridge the payment gaps and keep the business afloat. With this type of financing, small and growing businesses don’t have to be solely dependent on accounts receivables to fund their daily operational needs.
Speed and Flexibility
Working capital loans are usually processed more quickly than other types of loans, as most online businesses use this money to meet their urgent cash flow needs. Lending institutions understand this and have, therefore, developed faster processing and approval methods for these loans. In addition, many lending institutions also offer more flexible repayment terms to small businesses seeking working capital loans.
Zero Collateral
If you have good business and personal credit scores, then most lenders would approve you for a working capital loan with zero collateral requirements. Not only does this make it easier for small businesses to access the funds they need to sustain their operations, but getting an unsecured loan from a reputed financial institution will also help improve the credibility of your business.
How Does It Differ from Other Types of Online Business Financing?
Working capital financing has certain distinct features that set it apart from other types of business loans. These are as follows:
- Working capital loans are short-term in nature, typically lasting a year or less. On the other hand, traditional, long-term business loans have a term between a few years and over two decades.
- Working capital financing often has a revolving structure, allowing businesses to borrow money and make repayments over and over again, as needed. This contrasts with most traditional business loans with a fixed repayment term.
- When granting working capital financing, lenders focus less on collateral assets and more on creditworthiness, cash flow, business performance, and other such factors. Long-term business loans, by contrast, have much stricter collateral requirements.
- Compared to traditional long-term business loans, working capital loans can usually be obtained relatively quickly since they’re needed to cover immediate cashflow gaps or seize short-term growth opportunities.
Common Types of Working Capital Financing
Working capital loans can be structured in a variety of ways. Some of the most common types are:
Revenue Based Financing
Revenue based financing allows you to receive a lump sum and pay back the loan based on a percentage of monthly gross revenue. You don’t need the best credit score to get this loan, but you will have to fulfill the lender’s minimum annual gross revenue requirement.
This type of financing offers a more flexible payment option. Your loan payments will be lower when you have a slower season. However, you will end up with a higher payment for the month if your business experiences record-breaking sales. Online business owners gravitate toward this option when they want capital but don’t have enough space in their budgets for fixed monthly payments.
Stenn offers revenue-based financing as a strategic funding solution specially designed for eCommerce businesses. With a strong track record in financing eCommerce and SaaS businesses, Stenn understands the unique financial needs of modern companies. Their team works closely with each client to tailor financing solutions that align with their growth objectives and financial goals. To determine if your business qualifies for its innovative eCommerce financing solution to grow your business, fill out this form to get detailed information on how it works and next steps.
Business Lines of Credit
A business line of credit provides you with a preset credit limit and allows you to borrow as much or as little as you need without exceeding that limit. You can draw on the business line of credit as often as necessary and only need to pay interest on the amount you’ve borrowed instead of the total credit limit. The repayment terms are usually set to be quite short, such as a year or less. Any remaining balance on your business line of credit will become a business loan if you do not pay it off after the draw period.
Merchant Cash Advances
This is an alternative form of working capital financing that allows you to access a lump sum of cash in return for a percentage of your future credit and debit card sales. However, this financing option has relatively high fees, making it more expensive than the others.
Short-Term Loans
With this type of working capital financing, the lender will offer you a lump sum of as much as $500k to cover your day-to-day operational needs. Over the next three to 18 months, you’ll need to pay off this amount, along with the interest. You’ll need to have a good credit score and sizeable collateral in order to qualify for this type of working capital loan.
Invoice Factoring
This working capital financing method allows you to trade your unpaid invoices for an upfront lump sum payment. The lender buys your unpaid invoices in return for a sizeable upfront cash payment, which is less than the total amount receivable from the invoices. It then collects the pending payments from your customers or clients to make a profit. This is a good way to raise working capital if you have a poor credit score or payment history.
Invoice Financing
This financing method is similar to invoice factoring. You receive funds equal to a percentage of your invoice’s value. However, invoice financing is a loan. You still have to collect invoice payments from clients. An invoice factoring company will not do it for you. Some online business owners prefer to handle the communication on their own since a pushy invoice factoring company may ruin a relationship with a good customer.
SBA Loans
If you have a good credit score, you should apply for a working capital loan backed by the U.S. Small Business Administration (SBA). These loans are popular among business owners since they offer low-interest rates and favorable repayment terms. You can apply for the SBA 7(a) term loans to fund your business’s day-to-day operations while expanding or pivoting to a new industry.
Business Credit Card
A business credit card can provide your business with revolving credit and a credit-building opportunity. You can use the card to purchase inventory, make debt payments, and cover any other short-term expenses that might come up. It’ll help keep your business and personal finances separate while also offering benefits like expense tracking and rewards programs.
How to Choose the Right Working Capital Financing Option for Your Online Business
Now that you know about the different working capital financing options, you’ll need to figure out which one is right for you. And the best way to do that is to ask yourself the following questions:
What Is Your Credit Score?
Your credit score will greatly impact your ability to qualify for working capital financing. If you have a good to excellent credit score, you should apply for a short-term loan or business line of credit from a reputed bank or other financial institution.
This will allow you to borrow the working capital you need at relatively low interest rates, especially if the loan is guaranteed by the SBA.
On the other hand, if you have a poor credit score, you may have to opt for merchant cash advances or invoice factoring, which have higher fees but don’t put as much weight on the borrower’s credit score.
How Much Collateral Can You Offer?
Another factor to consider is whether you’re looking for a secured or unsecured loan. For example, if you have some assets that you can offer as collateral, then a short-term installment loan might be the best option to tide you over any temporary gaps in your cash flow.
On the other hand, if you don’t want to put up a physical asset as collateral for the loan, then you should apply for a business line of credit, merchant cash advance, or a business credit card. These typically have a higher interest rate but don’t require collateral so long as your business generates a steady stream of revenue.
What Type of Loan Do You Need?
Lastly, you have to figure out what type of financing your business currently needs. Do you need a lump sum of cash that you can repay over a preset repayment schedule? Or do you need to draw small sums of money over an extended period to fund the day-to-day operations of your business?
Depending on your answer to this question, you’ll have to choose between a short-term installment loan (which provides you with a lump sum), a revolving line of credit, or a business credit card (which allows you to draw small sums of money as needed).
How to Grow Your Online Business with Working Capital Financing
Here are a few of the important ways you can use a working capital loan to help your business grow and flourish.
Improve Cash Flow
Short-term cash flow problems (such as a delayed payment from a client) can make your business unable to function, as you will not be able to pay for inventory, utilities, or even the salaries of your employees.
A timely working capital loan can prevent such a disaster by providing you with the cash you need to cover your short-term liabilities and keep the business running. This, in turn, will make your business more resilient by minimizing your dependence on incoming revenues.
Cover Short-Term Expenses and Purchases
A working capital loan can be used to purchase new equipment needed to grow production capabilities or to buy inventory for a new branch of the business that is not yet self-sufficient.
All of these activities are designed to help your business grow and prosper in the long term, but they require some upfront investment. And this is where working capital financing can be beneficial for growth, as long as it’s used responsibly.
Sustain Business Operations
Essential business operations like procurement, manufacturing and sales can be disrupted due to insufficient working capital. This could lead to unfulfilled orders, poor quality of products and services, and dissatisfied customers – which would have a negative impact on your company’s reputation and future growth prospects.
A timely working capital loan can prevent this by bridging the gap in cash flow and allowing you to seamlessly meet your customers’ demands. This would help keep your business afloat in the short term and build your brand image so that the business can grow and prosper in the long term.
Boost Supplier Relationships
In order to achieve long-term growth, a business must have a strong relationship with its suppliers. This is needed for favorable pricing and discounts on raw materials, reliable and timely deliveries of materials, better negotiation terms, and quality assurance on the raw materials purchased.
A working capital loan can help ensure that you pay your suppliers in a timely manner, demonstrating that you are a reliable business partner. This will help build trust with your suppliers, making them want to work with you in the future. A good reputation will also increase your negotiating power in future transactions.
Build A Reputation for Your Online Business
Choosing the right working capital loan could help you increase customer satisfaction, improve your brand image, build trust with suppliers, and enhance your company’s reputation and credibility.
Reputation is one of the most important factors determining your business’s growth and long-term success. Customers are much more likely to buy from a company that enjoys goodwill within the community.
Purchase More Stock and Inventory
Acquiring more stock and inventory can help you serve more customers. Some online businesses do not have enough inventory to serve a surge in demand. You can use working capital funding to prepare for busier seasons while you are in the middle of a slower season.
Go Into New Markets
Working capital can be used by online businesses to explore new markets. You can invest in real estate to establish a physical presence or list your products on additional marketplaces.
Expand Your Product Line or Services
Offering multiple products and services can increase the average lifetime value of each customer. Some online business owners don’t have enough current assets to expand their product lines or services. The extra capital from working capital financing can give you what you need to launch your next project.
Hire Staff
Online businesses rely on staff to fulfill product orders and ensure everything runs smoothly. A working capital loan can improve your company’s financial health and make it easier to hire staff. You can also use the funds to retain your current workers during slower months. Hiring more staff and retaining your top workers can be profitable in the long run.
Improve Advertising and Marketing
You can have the best product, but it won’t matter if you do not have good publicity. Advertising and marketing campaigns put you in front of more people and can turn strangers into loyal customers.
Working capital can make it easier to initiate these campaigns and double down on the advertising and marketing channels that are the most effective for your online business. You will learn more about advertising and marketing with each campaign that you run. Getting extra capital can speed up the learning curve and help you reach your long-term revenue goals sooner.
Invest in Technology and Digital Software
Online businesses often use technology and digital software to communicate with customers, list their products, and perform other critical tasks. Some companies outgrow their existing software and need additional solutions to reach the next level.
Working capital loans allow online business owners to get what they need right now instead of waiting until they have enough funds. With the right technology, some business owners can become more productive and generate more revenue.
Conclusion: Maximizing the Benefits of Working Capital Financing for Your Online Business
Properly managing cash flow within your business is essential for long-term sustainability and growth. To maintain a healthy flow of working capital, you can optimize the accounts receivable process for on-time payments, keep an accurate record of your debt payments every month, and manage inventory for maximum efficiency.
Lastly, you can choose among a variety of working capital financing options so your business operations can continue without a hitch, even when there’s a cash shortfall. The right type of working capital loan for your business will depend on your goals, industry, and circumstances.
