Working capital loans are now more important than ever for small business survival.
The coronavirus pandemic and global economic recession started in 2020 impacting the world in a great number of ways.
Millions of businesses have already suffered from this crisis and it’s expected that more will follow as it continues.
The main problem for SMEs is the lack of cash flow due to both lockdowns and a general reduction in revenues.
Therefore, obtaining working capital finance is now essential to help businesses stay afloat until the situation improves.
However, not only is it difficult to get a loan right now but it’s also important to understand whether more debt is a wise choice.
You need to consider pros and cons of financing to make a decision that will be best in the long term.
Working Capital Loans Explained
A working capital loan literally is a “quick fix” with the sole purpose of tiding your business over through a rough patch.
That’s why so many people turn to this financing in the current situation.
However, this is also the reason why one needs to be extremely careful when considering working capital finance.
Due to the fact that these loans are designed to be short-term measures, they have some disadvantages.
However, business owners can resort to them if pros outweigh the cons in your particular situation.
Working capital loans are mostly used to cover the following costs:
- Daily business operations
- Debt payments
These loans are most popular with seasonal businesses that often require financing to operate during the off-season period.
They are also a reasonable solution for some emergencies.
However, you’ll need to be even more careful with accruing this kind of debt in this situation.
It’s also important to understand that while working capital finance options vary, many of them are tied to personal credit.
This means that you, as a business owner, will take a lot of personal risk with this debt.
The good news is that this problem is mostly solved by using online lenders.
These alternative financing providers are much more lenient with their loan eligibility terms than banks.
Online lenders often require minimum paperwork and offer unsecured loans.
Therefore, your business might be able to get the money it needs in less than 24 hours and it only has to meet quite reasonable annual revenue requirements.
You can find both secured and unsecured working capital finance in Australia rather easily with a simple Google search.
Just check reviews to find the leaders in the industry. Today they are Prospa, Capify, GetCapital, and OnDeck.
Pros and Cons of Working Capital Finance
Before you start the easy process of applying for working capital loans today, you need to consider the advantages and disadvantages of this financing.
Its benefits are rather obvious:
- You get cash flow when your business needs to cover an immediate gap in capital expenditures.
- A working capital loan can be obtained very fast. Online lenders can give you approval and send cash to your account within hours of the initial application.
- This type of financing doesn’t rely on an equity transaction. Again, this makes it easier to obtain even for businesses that don’t have collateral or a very good credit score. Also, you get to keep full control of your business regardless of this new debt.
The purpose of working capital finance is to provide small businesses with immediate help when they need it.
The benefits offered by this financing reflect that. However, this help comes at a price.
This is the reason why these loans should only be used as a short-term measure.
The main cons of working capital loans include:
- These loans will always have a rather high interest rate. The exact rate will vary depending on the lender, collateral, and the borrower’s credit score. However, it’s essential to understand that you won’t benefit from the fact that interest rates go down during a recession. This is why you should be extremely careful when choosing this type of financing. Some short-term loans can have interest rates up to 200%.
- Repayment terms on short-term loans can be highly unfavorable. For example, you might not be able to pay off the loan early. Therefore, you won’t be able to really use it as a stopgap measure in an emergency.
- Working capital finance is often tied to the personal credit of the business owner.
When to Use Working Capital Loans
It’s very important to understand that working capital finance is very high-risk.
This is why the interest rates are so high as this is the only way for lenders to reduce the risks for themselves.
However, as a business owner, you also take a risk by getting into debt that might pull your company under very fast.
That’s why you should only use these loans when you are confident in your ability to repay them fast.
It’s essential to have a plan in place before you apply for this financing.
For example, this will be a good idea if you have outstanding invoices and only need to wait for a few weeks until the payment comes through.
However, even in this situation you need to weigh the benefits of getting a cash injection over the value of money you will definitely lose due to the cost of the quick loan.
This debt is a short-term measure, but you need to consider its long-term consequences for your business plan and budget.
When to Avoid Apply for Working Capital Finance
Businesses that are sensitive to high interest loans or have no sure way to repay them quick should avoid working capital loans.
It’s important not to let desperation to cloud your judgement.
If your company has no viable way to get cash through revenue, you should only consider this financing as a way to support the business until you get approved for a long-term loan.
However, at this moment this can be difficult.
Traditional lenders, big banks and credit unions, make their eligibility terms more stringent during a crisis.
Therefore, it will be nearly impossible for a small business to get approval during this recession.
The majority of lenders have stopped loan origination completely. The situation is now improving as more investors offer capital to fintech unicorns.
However, this progress is slow. Therefore, working capital loans today are harder to get, which makes them riskier.
All in all, working capital financing should not be your first go-to option. Before you start looking for these loans, you should consider less risky types of financing.
It’s also important to explore any small business grants and financing support offered by the government.
These options are versatile and can help SMEs pay for specific capital expenditures, like payroll.
At the moment, the majority of these support programs are focused on relief for the COVID-19 pandemic.
However, there are other specialized loans and grants dedicated to niche small business support.
Therefore, be sure to consider all your options before making the financing decisions.