Working Capital Term Loan

One of the most common expressions used to describe the current state of a small business's finances is "working capital." The term refers to the money that a business needs to operate and bring it into profitability. Every commercial bank, credit union, and financial lending firm have a working capital management department that deals with all aspects of the loan process.

The purpose behind working capital management is to ensure that loans are repaid. Banks borrow money from you in order to expand their capacity; they do this by making loans known as Working Capital Loans. They then use the funds to purchase assets, such as land or equipment, and to make new loans, called revolving credit. At the end of each day, the total amount of Working Capital Loan Debt owed by the business is the difference between the current market value of each asset and the total outstanding on all Working Capital Loans. The term "working capital," therefore, simply refers to the difference between cash coming in and cash going out.

There are several types of working capital term loan available to businesses. One type is a business loan. A business loan is simply a loan that is made to a business based upon the assets it possesses and the potential it has for future profit growth. The assets must be tangible assets (e.g., a building) or non-tangible assets (e.g., accounts receivable). The future profit projection of the business is considered a part of the loan equation.

Another type of working capital loan is a short term cash advance. This is another type of borrowing that involves cash that is not based on tangible assets. Instead, the borrower uses an agreed upon amount of net debt (e.g., a merchant cash advance) and receives cash advance payments from a lending source for a pre-determined period of time. These advances are paid on a weekly or bi-weekly basis. In many instances, a business is approved for up to thirty days to use this type of loan. However, if the loan is applied for and not repaid in the specified amount of time, interest will begin accruing on the amount of the outstanding loan.

The third type of working capital term loan is an unsecured business loan. An unsecured working capital term loan is simply a loan where the lender relies on the trustworthiness of the borrower. If the borrower fails to make the repayment, the lender may have no other recourse but to relinquish the working capital. If a business is in good standing with its local credit association, most lenders will be willing to issue working capital advances without requiring as much collateral.

Businesses need to understand how their working capital changes throughout the year. Most business plans budgeted for operating expenses should show a healthy cash flow. However, in light of seasonal issues such as bad weather, power outages, and bankruptcy, it is important that a company review its working capital management policies to see what impact these issues will have on its ability to sustain operations through the period just before each new season begins.

Every working capital term loan should contain a detailed description of the loan's specific requirements. These requirements should include the loan's interest rate, the maximum amount of loaned, the payment terms, and the grace period. By doing this, business owners will know in advance whether they are in compliance with their specific funding needs. Likewise, working capital funds should be replenished regularly to keep businesses functioning smoothly. In addition to keeping working capital levels within acceptable limits, regular refinancing helps to reduce a business owner's financial worries and significantly increases the amount of working capital left at the end of the month.

To learn more about working capital and short term loans, a business owner might want to refer to "Working Capital: Business Basics" by Bill Dickel (2003). Another useful source for learning about working capital finance is "Securing Commercial Real Estate Loans" by B.L. & R. Pack (forthcoming, pdf). Working capital should be treated carefully and consistently, so that it can maintain or improve the cash flow that a business needs to remain viable.