7 working capital loans for small businesses and startups.

A business needs cash — or working capital — to cover its daily operations such as payroll, rent, and inventory. Small business working capital loans are a type of business financing that helps a company get through a short-term cash crunch. Needing a working capital loan doesn’t mean your business is a failure — many startups experience cash ebbs and flows as some months generate more income or expenses than others.

The most common reasons to get a working capital loan.

A cash flow loan doesn’t always mean a business is declining. In some cases, it could be a sign that a company is experiencing a spike in growth. Here are four reasons a small business may need a working capital loan.

Fluctuating sales.

As mentioned, most companies experience cash ebbs and flows. Some businesses are seasonal — sales may be slower during certain times of the year than others. Others may buy inventory that could take several months to deliver, requiring an investment that can’t be converted into cash sales until it’s received. A working capital loan can help a business get through a higher expense period or slower sales months.

Inconsistent accounts receivable.

If your customers don’t promptly pay their invoices, your business’s liquidity will suffer. Irregular cash flow makes it difficult to pay bills on time or forecast your working capital needs. Improving your invoicing and accounts receivable (AR) process should be the first step to stabilizing your company. Working capital loans give you the liquidity you need until you successfully implement new AR policies.

Business growth spurts.

A startup can suffer from cash flow issues when demand is higher than its ability to capitalize on the increased business. Cash flow loans may help fund growth quickly, so a startup can hire new employees and invest in additional software or equipment to take advantage.

New business opportunities.

Some of the best business opportunities arrive unexpectedly. And some of the best investments may not return profits immediately. Having to pass up on market share because of a lack of cash can be crippling to a business. A working capital loan can help small business owners jump on opportunities when they arise — and fund them until they provide a return.

7 types of working capital loans.

Working capital loans target short-term goals, such as covering payroll or funding an inventory purchase. They fund faster than a traditional loan and have shorter repayment terms because they aim to get a business out of a tight spot. Here are seven common types of working capital loans.

1. Business credit cards.

Although not a traditional loan, a business or corporate credit card could provide fast funding to cover unexpected short-term expenses. Financing your working capital needs by using a company credit card has the added benefit of improving your company’s credit score, giving you access to more favorable terms and interest rates for future loans. 

The Brex corporate card for startups does not require personal guarantees and allows companies to earn points for spending that can be redeemed for travel and other rewards.

2. Cash flow loans.

Cash flow or short-term loans are similar to term or installment loans because they provide a lump sum that must be paid back in installments over a set amount of time. Unlike term loans, cash flow loan providers charge you fixed fees instead of interest. 

3. Invoice financing.

Small businesses with a sizable amount of unpaid invoices can turn to alternative lenders such as Bluevine and Fundbox to borrow against outstanding invoices due. Also known as invoice factoring, the entire process can be completed online. Set up an account, submit the invoices you’d like to borrow against, and receive an answer the next business day.

4. Working capital line of credit.

Banks are the most common sources for small business lines of credit. When a financial institution approves your business for a line of credit, you’re given access to a certain amount of money. Borrow a portion — or the entire amount — as often as you’d like. The funds will be available the next time you need them, as long as you pay back the loan. 

Small businesses with recurring cash flow shortages could benefit most because they don’t have to apply for additional financing. Even companies that aren’t experiencing cash flow shortages should consider opening a small business line of credit to capitalize on opportunities or cover unforeseen expenses. 

5. Merchant cash advance.

If a large portion of your income comes from credit card transactions, you may qualify for a merchant cash advance. Merchant cash advance providers will advance your business the cash it needs by “purchasing a percentage of your future credit card receivables.”

The company will advance you the money you need and take an agreed-upon percentage of your credit card income each day to repay the advance, plus interest and fees. Consider other working capital loan alternatives before turning to merchant cash advances — the fees can be high, and your personal credit score will be on the line.

6. Small Business Administration (SBA) 7(a) loan.

The SBA provides government-backed 7(a) loans that can be used for working capital. SBA small business loans are among the best financing options for companies with little collateral or credit history because the SBA guarantees a portion of the loan.

There’s one big catch when qualifying for an SBA 7(a) loan, especially if you’re in a hurry — the approval process can take as long as 90 days.

7. Term or installment loans.

Term loans are the most common form of financing for startups and provide working capital, which must be repaid over a specific period. Alternative online lenders offer a quick application process to fund a business fast. Typically, you must repay working capital or cash flow loans in one year or less.

How much working capital does your business need?

If you’re wondering how much you should borrow, remember that a working capital loan is designed to cover short-term expenses. These costs might include payroll over the next few weeks or months, a large inventory purchase, or an upcoming tax bill. 

If you’re borrowing a set amount of money in the form of a working capital loan or against the value of your unpaid receivables, calculating the loan amount you need by tallying your upcoming expenses works well.

If you’re considering a small business line of credit or credit card where you have access to funding over a longer period of time, the working capital formula could give you a ballpark figure of how much credit you should request. Calculate the working capital ratio as follows:

Working capital ratio = current assets / current liabilities

Say your startup has $20,000 in assets and $18,000 in liabilities. Dividing the two gives you a ratio of 1.11. An ideal ratio may be somewhere closer to 1.5. 

At the current working capital ratio, you may have difficulty paying your expenses. Having access to an additional $5,000 from a business credit card or line of credit pushes your ratio up to 1.38, giving you some cash cushioning to meet expenses.

Working capital loans for startups — are they worth it?

Most companies have cash flow issues at some point. A cash flow loan can provide business owners with the liquidity necessary to meet short-term obligations such as rent and payroll.

There are several funding options for small businesses and startups, although they’re not all ideal. It’s best to carefully consider alternatives and compare loan costs and terms to find the best short-term solution for your business.