How to Determine If Your Small Business Needs a Working Capital Loan

Desireé Duffy  |

Need for more inventory, but the payment won’t come in for another two months? You may need more working capital, and fast.

However, first, let’s talk about what working capital is.

The accepted definition of the term ‘working capital’ amounts to the difference between a business’ current assets, such things as an account receivable, inventories, and petty cash, minus all current liabilities (which usually means the accounts payable on hand). To calculate the amount of working capital on hand, use this basic equation:

Current Assets - Current Liabilities = Working Capital.

Or put another way, it’s the cash in the bank today while waiting on payments due from customers.

Working capital is most often used for things like salaries, inventory, vendor payments, and emergencies that inevitably pop up. It sounds simple, but taking care of this essential asset can easily fall through the cracks. Professional business owners need to understand the basics of working capital if they’re to become and stay successful and solvent.

No matter what kind of business you have, it is critical that your source of working capital should be easily available.

When to Get a Working Capital Loan

What happens when you don’t have enough capital to make an inventory to pay salaries? It’s every business owner’s nightmare, but there is a solution: loans.

It may sound intimating, but working capital loans can benefit your business if used correctly, and at the right time.

Here are the two most common situations in which a working capital loan makes the most sense:

Operation Cost Overruns

There are times for almost every business when covering on-hand costs with current assets is impossible, usually due to unforeseen emergencies and circumstances. The smart business owner realizes that to go to a bank for a small working capital loan, paperwork and other preparations that need to be done ahead of time so that the waiting period is not too long. Otherwise the turnaround time, even at a bank that does want to help, can be excruciatingly long. “In some cases, it may be smart to turn to an alternative lender,” says Canada based Evolocity, “especially when timing is a critical issue.” They tend to be much faster at processing loan requests than a traditional bank.

The Loan Will Become Guaranteed Profit

Savvy business people are always looking for ways to turn current debt into assured profit. In other words, when an influx of working capital is guaranteed to not only cover the cost of the loan but produce a tidy profit above and beyond the loan payback, it just makes sense to do it. For instance, before a business cycle peaks, if there isn’t enough cash on hand to cover expected inventory sales, a loan will provide the financing for the needed inventory, which in turn will assure extra income when sales do peak. It’s like buying more money than you paid for.

Managing Working Capital

Don’t let the pay cycles of vendors and creditors create a monthly black hole that causes the accounting department to push the panic button. Always plan on staggering payments to create a ­­­­smoother, steadier working capital situation. Although everyone marks their bills with a ‘pay by’ date, it’s always possible to find some wiggle room with creditors when they know the business is financially healthy and has a reputation of always paying its bills in full.

One last thing: Make sure to secure a rainy-day fund for those unexpected emergencies that are an inevitable part of doing business. Also, make sure that the business already has a secure credit pipeline with a bank or other financial institution, so when it’s time for a working capital loan, there’s no need to start searching frantically for resources.

So, do you need a working capital loan? The decision is up to you – but remember, it can be a useful asset to sustain and grow your business if used properly.

DISCLOSURE: I have no financial interests in the companies in the this article.


The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer

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