Various small businesses may require a term loan at some point in their venture in order to help with long term or short term goals. A working capital loan is considered to be a short-term loan that is meant to help a small business with their every-day expenses, such as paying employees’ wages, dealing with their accounts payable, bridging the gap between a customer’s credit payment and paying bills, and other common expenses incurred by a small business operation. This type of loan is not meant for any long-term goals, or any type of asset management.
How Working Capital Loans Work
It is quite common for various small businesses to be incapable of meeting certain expenses on occasion in relation to their day-to-day expenses. In these cases, small business owners may apply for a working capital loan to help them cover certain expenses that help them continue to run their operation smoothly. Whether wages need to be paid, or rent needs to be covered, a working capital loan can help these small businesses attain the necessary funds for these smaller-scale expenses.
Working capital loans only cover expenses that have been incurred by existing capital – these loans are not meant to obtain any capital required to expand. Small businesses require a somewhat high credit rating in order to be approved. A small business must be able to project that their monthly revenue will meet and exceed their monthly expenses when taking out working capital loans. These loans are meant to help out a small business until they are able to reach an adequate monthly revenue.
Types of Working Capital Loans
As a small business grows, revenues will continue to grow and will eventually meet and exceed expenses if all goes as planned. Until the business’ revenue is able to cover all expenses, a working capital loan will help keep a small business afloat as it strives to achieve this positive revenue stream. Most small businesses would be unable to generate profits to survive without the temporary aid of a loan like a working capital financing program. Small businesses can use the funds provided from such a loan to pay for any number of things, such as:
- Mortgage payments
- Employee Wages
- Marketing expenses
Here is a list of five popular types of working capital loans:
Trade Creditor – A trade creditor provides loans to small businesses who buy large amounts of product or services from their own businesses, which serves as a sort of trade. These trade creditors require the small business to have a good business credit history prior to approving a loan.
Short Term Loan – Banks provide these loans to help a business purchase inventory and other necessities to keep the business running profitably. These loans are generally provided for cyclical or seasonal expenses that occur during specific times of the year.
Equity – The money that comes from equity is obtained from personal assets, such as the equity in a home or equity from angel investors.
Cash Advances/Cash Factoring – Small businesses who’s customers use credit cards extensively can sell their future anticipated credit card receipts to obtain instant funding. In addition, accounts receivable can also be sold to a factoring company for immediate capital.
Line of Credit – A bank can provide a small business with a line of credit which provides the business with instant funds required for a variety of expenses. A line of credit is an account that allows the business owner to withdraw cash up to a specific maximum amount, which is charged interest only on the amount withdrawn. Business owners are free to repay and then re-borrow the money as often as they wish, as long as the terms of the line of credit account are followed.
Benefits of Working Capital Loans
Small businesses can benefit from working capital loans to help them buy time as they strive to establish a positive revenue stream to help keep up with day-to-day expenses. Some of the major benefits of working capital loans include the following:
Maintaining Ownership – Working capital loans help the business owner to retain the same level of ownership. In contrast to traditional loans, working capital loans allow business owners to sell their own capital or inventory for cash in order to keep up with certain expenses. Other types of loans can increase the number of owners, therefore reducing the current owner’s percentage of ownership.
Self Reliance – Since the funds received from a working capital loan come from the sale of the business’ own assets, the owner can maintain some pride knowing that they are being self reliant with a working capital loan.
No Interest Charged – There is no interest charged on the funds loaned considering the fact that it is the business’ assets themselves that are providing the loan. The business is free to use the funds necessary after converting their capital into cash, without having to add interest to the principal.
Obtaining a working capital loan to fund a small business can be a viable way of getting immediate cash required for the business’ activities, without incurring some of the stipulations and drawbacks from traditional business loans. Taking advantage of these loans can help a small business develop and get off its feet, and become profitable even during times of financial need.
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Small businesses will often require financial assistance when starting up or expanding. Many of these businesses will not be able to gain approval for a traditional loan from a conventional bank on reasonable and general terms. In these cases, small businesses have the option to take advantage of loan programs that provide funds to small businesses that are guaranteed by the SBA – or the Small Business Administration. The majority of private lenders in the US are well versed in SBA loans, and are therefore able to help small business owners gain access to an SBA loan who otherwise cannot get approved for a conventional loan.
Banks and other lending facilities are able to offer these term loans to small businesses which are guaranteed by the SBA by as much as 80% of the loan principal. This guarantee by the SBA provides the lender with a smaller risk, and also helps the lender to give the borrower the necessary loan that would otherwise be impossible under traditional terms.
Various Types of SBA Loan Programs
There are a few popular SBA loan programs available for small business owners that find it challenging to get approved for a conventional loan, including the following:
7(a) Guaranteed Loan Program
The 7(a) Guaranteed Loan Program is the main loan program offered by the SBA. Many small businesses that are just starting up can take advantage of this loan program, as well as established businesses that require some form of short-term or long-term loan assistance for things such as purchasing inventory, making building improvements, or assisting in working capital. A 7(a) Guaranteed Loan Program can usually guarantee up to $750,000 – up to 80% is guaranteed for loans up to $100,000, and 75% for loans over $100,000.
Businesses who wish to participate in a 7(a) Guaranteed Loan Program need to prove that they are indeed classified as a small business. Interest rates charged to small businesses on a 7(a) Guaranteed Loan Program are based on the current prime rate.
504 Local Development Company Program
This SBA loan program is available to small businesses who need assistance in purchasing equipment, machinery or real estate. These are long-term business loans that are provided at a fixed rate, and are executed by Certified Development Companies through lending facilities. Small businesses must be the type that benefit the community or business district revitalization, or help out in rural development. Having these credentials helps these small businesses exchange these requirements for below-market, fixed-rate financing. Generally speaking, 50% of the 504 loan is financed by the bank, 40% is financed by the Certified Development Companies, and 10% is funded by the business.
The MicroLoan Program
The MicroLoan Program provides funding to small businesses who require a small loan that would otherwise be too small to acquire through a traditional loan from the bank. These loans can range anywhere from a few hundred dollars to $25,000. Although the funds from this loan may not be applied to purchasing real estate or paying off outstanding debt, they can be used to buy inventory, machinery, equipment, furniture and other supplies.
These loans are not guaranteed by the SBA, but are provided by intermediate lenders. Generally, non-profit organizations help to facilitate these microloans to small businesses who meet the necessary requirements. These organizations are actually considered SBA Microloan Lenders, and obtain loans from the SBA which help them provide much smaller loans to small businesses who require financial assistance.
Although the 7(a) Guaranteed Loan Program, 504 Local Development Company Program and The MicroLoan Program are the three main loan programs offered by the SBA, there are many other types of programs offered as well:
- Loans to assist small businesses in complying with federal air and water pollution regulations, as well as occupational safety and health regulations;
- Loans to help offset problems evoked by certain federal actions;
- Loans to help alleviate the economic injury of a small business caused by energy or material inadequacies;
- Loans for the expansion of a small industrial businesses;
- Community Adjustment and Investment Program loans to help develop new jobs and preserve existing jobs in sectors that are at risk;
- Energy and Conservation loans for small businesses involved in distributing, marketing, engineering or manufacturing that is designed to conserve the country’s energy resources.
Eligibility of an SBA Loan Program
There are certain requirements that small businesses must meet in order to be approved for an SBA loan program, including the following:
- Be independently owned and operated;
- Be subordinate in that particular sector;
- Meet employment and/or sales standards;
- Not be related to gambling, media, investing, amusement or lending.
In addition, these loans may not be utilized for the following purposes:
- Paying off outstanding debt;
- Refinancing debt;
- Expanding to an added location;
- Buying real estate for investment;
- Starting another business venture in addition to the current one;
- Developing a business that will be absent of ownership.
An SBA loan can provide an eligible small business with the necessary funds required for a variety of reasons, when a conventional loan is not possible. Although there are a few stipulations that must be met in order to be approved for one of the loan programs that the SBA offers, those businesses that do qualify can get the financial assistance needed to remain competitive and profitable in their field.
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Small business owners often find themselves in a position where cash flow management becomes difficult and problematic, particularly during certain times of the year and throughout seasonal credit demands. There are often time periods where time gaps exists between capital requirements and profits/revenue. Small businesses that are just getting off the ground are more susceptible to these revenue gaps, considering the fact that they are very early in the development stages of the business, and have not had sufficient time to generate enough of a positive cash flow to keep them afloat.
Major issues with cash flow can become problematic if not enough capital has been generated in between purchasing inventory and collecting revenue. This is one of the major reasons why small businesses run into severe financial problems that end up forcing them to shut down business for good. Even though on paper it looks like the small business is making a profit, the cash is often just not there.
Business Line of Credit Explained
A line of credit can help these small businesses stay on top of their cash flow by providing them with the necessary funds needed, particularly during seasonal times where more cash is required. Banks will loan a small business a certain amount of money for cash flow purposes with a line of credit, where a line of credit account is kept at the bank, and the business simply withdraws from this account whenever a certain amount of money is required. Although the interest rate charged on a line of credit is generally higher than that of a traditional loan, a business owner will only be charged interest for the amount withdrawn from the line of credit account. These types of lines of credit are often referred to as “overdraft” lines considering the fact that overdrafts from a small business’ cash flow are funded from these line of credit accounts.
Getting Approved for a Line of Credit for Your Small Business Venture
Most banks offer lines of credit to individuals and businesses that qualify. A small business’ ability to get approved for a line of credit all depends on whether or not the business is capable of repaying the borrowed amount, in addition to the personal assets of the business’ owner. For example, business owners may sometimes have to offer a second mortgage on their home or the cash value of any life insurance policies as collateral to gain approval for a line of credit for their small business.
Start-up small business ventures may be eligible for approval for a line of credit as an unsecured loan as well if the business can prove that it is capable of generating consistent earnings, and possesses a strong position in capital. In addition, banks will look more favorably upon those businesses that can demonstrate multiple repayment sources.
Having multiple sources of repayment is an important aspect in getting approved for a line of credit. Banks feel more secure issuing a line of credit loan if they know that the business is able to repay the outstanding amount if the prime source of repayment falters. During adverse circumstances, banks like to see that a business operation has other methods of repayment in case inventory doesn’t sell, for example. Secondary available repayment sources are a great feature when looking for eligibility for a line of credit loan from a lending institution.
Repayment of an Established Line of Credit
When approved for a line of credit, the bank will generally provide a specific maximum amount of funds in an account from where a business may borrow the cash as required. Whether new equipment needs to be purchased, or bridging the gap between credit customers paying for their services, money can be withdrawn from this line of credit account to cover the costs during these seasonal and cyclical times of cash flow assistance requirements. During the agreed-upon time period, a business owner may repay and re-borrow the money from within the line of credit account, and interest is only paid on the amount of the outstanding principal.
Part of the agreement for a line of credit with the bank may include the requirement of the business owner to pay down the line of credit when the payment schedule has not been adhered to. Even if the total amount is not due for repayment for a while, banks may not approve of business owners using funds from a line of credit account to manage general cash flow. Banks are only in the habit of approving lines of credit for businesses that require occasional assistance during certain periods where cyclical and seasonal borrowing is required by the small business.
Benefits of Establishing a Line of Credit
Having the peace of mind knowing that there is immediate cash available in case it is absolutely required can help keep a small business running with success. A line of credit account can be the ideal solution for small businesses who require a little extra cash during certain periods of the year to help keep cash flow running smoothly and expanding the business where necessary. There are many advantages to having a line of credit available to a small business, including the following:
- Improved Cash-Flow Management
- Emergency Funds Available When Needed
- Lower Interest Rate Charged in Comparison to Credit Cards
- Option to Re-Borrow and Repay as Required
A line of credit can provide a small business with just enough emergency funds required to solve immediate cash flow issues, and help to make the necessary purchasing of inventory possible to meet future demands. Establishing a line of credit account can be the ideal solution for a small business that simply needs some extra cash for a variety of reasons, without having to apply for a traditional loan.
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Small businesses will more often than not require some form of loan in order to get the business off the ground, or to help the established small business meet certain financial obligations. One of the ways that a small business may acquire this extra money is through a merchant cash advance. This type of loan provides an alternative to a conventional small business loan that can give the small business the working capital it requires to keep the business running smoothly. Any small business who’s credit card sales are very strong can take advantage of merchant cash advances, such as restaurants, retailers, grocers and other professional services.
Merchant Cash Advance – An Overview
Small businesses can get immediate cash necessary for any cash flow issue by selling part of their anticipated future credit card sales to a lender at a discounted price. Banks and other conventional lenders typically do not provide merchant cash advances – these types of short-term advances are usually provided by specialty finance companies. Sometimes referred to as “credit card receivables funding” or “credit card factoring”, this type of cash advance can give a small business immediate funds to take care of occasional small financial hurdles faced.
Eligibility Requirements for Approval For a Merchant Cash Advance
In general, small businesses must meet a few eligibility requirements in order to get approval for a merchant cash advance. Some of these include:
- The business has been in operation for at least 12 months
- Total gross sales must exceed $10,000 per month
- The business is free of any liens or judgements
- No bankruptcy has been filed in the last 12 months
- FICO scores are over 500
- The business has more than one year left on the lease contract if the premises is leased
- Credit card sales exceed $5,000 per month, with documentation to prove this fact
- The business is related to the restaurant, service or retail sector
The eligibility requirements are generally less stringent than what a small business would have to have to obtain a conventional small business loan. A merchant cash advance is not a loan per se, which means that certain types of documentation would not be required in order to get approved for a cash advance. Approval times for a merchant cash advance are typically much less than they would be for a typical small business loan. In addition, larger amounts of cash are able to be approved for with a merchant cash advance than with a traditional loan from a bank.
How Merchant Cash Advances Work
After the small business has entered into a contract with a specialized finance company, the small business will then sell part of its future credit card sales in order to obtain immediate cash for various funding purposes. This finance company will buy these anticipated credit card sales at a discounted rate. A repayment period will be stipulated in the contract, which generally gives the small business around 6 to 12 months to pay back the cash advance.
Repayment Structures for Merchant Cash Advances
Merchant cash advances are usually structured in one of three ways for repayment:
1) Direct Split – Whenever a small business batches out at the credit card processing stage, a percentage of that particular credit card sale will be automatically paid back to the cash advance company at an agreed-upon percentage.
2) Lock-Box Arrangement – Any credit card sales that the small business makes are automatically forwarded and placed into a lock-box. At this point, the proceeds are then split according to a previously stipulated rate, and a portion of these credit sales are taken by the cash advance provider.
3) ACH (Direct Debit) – This arrangement allows the cash advance provider to access the business’ daily account, and take an agreed-upon portion of the daily credit card sales of the small business.
Advantages to Merchant Cash Advances
There are many reasons why a small business would want to take out a merchant cash advance. Some of these key benefits include the following:
Raise Cash Right Away – If a small business needs cash right away, a merchant cash advance can provide the owner with funds immediately in order to take care of any financial hurdle the business may be facing at the time.
Simplified Application Process – The application process for a merchant cash advance is generally much shorter and easier than an application for a conventional small business loan from a traditional lender. Small businesses that may not have an ideal past financial history can have an easier time getting approved for a merchant cash advance as opposed to a typical bank loan.
No Credit or Collateral at Risk – Merchant cash advances can provide small business owners with a safer method of accessing quick cash. Considering the fact that this is a form of a sales transaction, and not a loan, a merchant cash advance will have no bearing on a business’ credit rating and will stay off any credit report. In addition, business owners do not have to worry about losing any valuable collateral if in default.
Payments Are Revenue-Based – Repayment terms are generally structured around how much the business makes throughout the months. Payments and collections are generally based on the business’ sales volume. Higher amounts are paid during busy sales months, while smaller amounts are collected during leaner months. This helps a small business to prevent any fund drainage from fixed sum payments that may not be able to be met in certain months.
Small businesses that have a large percentage of credit card sales can benefit greatly from a merchant cash advance. Considering the limited amount of hassle, and the rather simple application and approval process, a merchant cash advance can provide an attractive alternative to a traditional small business loan from a bank. For small businesses that require immediate access to cash, a merchant cash advance can be the perfect solution.
When negotiating a cash advance for a business, one of the issues which must be understood by the company requesting such a merchant cash advance is the fact that finance charges will be taken out of the initial sum that is given to the company and this means that anyone who is looking to figure out whether a particular amount of funding is going to be sufficient is going to want to consider looking into how the finance charges for that cash advance are going to reduce the overall amount that might be coming in on the check.
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Most small businesses often require some form of financing in order to get the business up and running, as well as to expand the business. Typically, small businesses have looked to conventional banks in order to get a loan, which is usually in the form of a term loan. These terms can have different lengths, from short, to intermediate to long term maturities. The length of the term of these loans will have varying repayment time periods, as well as various purposes for the loans.
Short-Term Loans Defined
Short-term loans have a very short maturity period – often less than one year. Most often, this is the type of loan that a small business will require, since it is a sort of loan that will help to meet an immediate need. Although short-term loans generally have a maturity period of one year, many small businesses usually pay the loan back in a much shorter time period. These short-term loans can give a small business the emergency funds required for whatever need without having to commit to a long term loan with a traditional bank.
Why Small Businesses Needs Short-Term Loans
There are a variety of reasons why a small business would require a short term loan. Some businesses may need to meet certain immediate expenses that will require assistance in funding. For example, there may be some problems or deficiencies that may arise, or defects on the premises that need to be fixed. Perhaps there are some payroll expenses that need to be addressed, or bills that need to be paid, such as on the accounts payable. There may be cash flow issues that require some temporary funding, or there might be some customers that are still owing on their credit. All these temporary situations can be potential reasons to obtain a short-term business loan, which can help a business to stay afloat while dealing with certain minor, temporary situations.
Another great use for a short term loan is for businesses who have particular seasons that are busier than others. For example, some form of retail business that has busy seasons may need some short term funding in order to stock up on inventory that they wouldn’t be able to fully pay for until after the busy season has passed. By obtaining a short-term loan, these small retail businesses are able to pay for the necessary inventory, and pay back the loan in full after the busy season has ended.
Eligibility For Short-Term Loan Approval
Short-term loans can be obtained from a number of types of lenders, such as a conventional bank, credit union, or some type of private lender. Whoever the lender happens to be, they will want to see some form of documentation proving the business’ ability to pay back the loan in full, and on time. This comprehensive documentation can come in the form of payment history for previous loans, payment history to suppliers and other creditors, as well as cash flow history for the previous few years. Income statements are also typical documentation that lenders like to look at to see if the business is financially capable of paying back a loan. After reviewing such documentation, the lender will assess whether the loan will be secured (by collateral), or if the loan will have to be unsecured.
Short-Term Loan Interest Rates
Generally speaking, short-term loans tend to have higher interest rates than those for long-term loans. There may be certain times during the economy, such as during a recession, where these short-term loan interest rates may be lower than on long-term loans. The comprehensive documentation that the small business provides to the lender will have some influence on the interest rate charged. In general, the interest rate will be the current prime interest rate plus a premium. If the small business presents a higher risk to the bank due to poorer documentation, this premium may be higher than others where the risk to the lender is lower.
The interest rate that is quoted by a lender can often be negotiated, especially with private lenders and other mutual lender companies. It is important for the small business owner to be knowledgeable about what the prime interest rate is in order to be able to professionally negotiate the premium charged. It is also important to note that the interest rate can be calculated in different ways – it is best for the small business owner to work with the lender to ensure that the interest rate is calculated in the most affordable way possible.
Small Businesses Just Starting Off
Small businesses that are just getting off the ground may have to have more extensive documentation to present to their lender in order to get approved for a short-term loan, considering the fact that there is no financial history of the company for the lender to look at. Generally, small businesses that are just starting off will need to have some type of collateral to offer the lender in order to be approved for a short-term loan – this means that only secured loans will often be approved in these situations.
These businesses will have to explain to the lender what their projected income and profit will be over the next few years, as well as where the funds are expected to come from. Small businesses are more likely to get approved for short-term loans as opposed to long-term loans considering their smaller risk.
Short-term loans are essential for many small businesses to help get up and running, and to get over the occasional financial hurdle that many of them face. Without the availability of short-term loans, many small businesses would not be able to continue. With the availability of short-term loans, small businesses can thrive, which can have a positive effect on the overall economy.
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