By Meredith Wood
Maintaining positive cash flow is a delicate act that is key to the survival of small businesses. With slow-paying clients, seasonality, or an unexpected opportunity such as a big order—many owners struggle to keep their working capital out of the red.
But given the natural ebbs and flows inherent in small business, finding yourself in a cash crunch will likely become a reality at some point in the life of your business. Just one supersized order can shift your working capital balance, and you don’t want your only option to be leaving money on the table. At the same time, letting your cash flow reach negative territory could inhibit your ability to pay creditors on time and in full, and in turn, hurt your credit score.
Fortunately, with the proliferation of alternative and online lending, there are several loan options that can help you improve your working capital position. They can be an excellent resource if used correctly.
Line of credit
Business accountants often recommend opening a line of credit because it gives your business access to working capital when you need it, but you only pay interest on what you actually use. You can use funds from a line of credit on a broad range of needs, including working capital, having an emergency or opportunity fund, or buying inventory or equipment.
On the downside, borrowers who open a line of credit are often required to show updated financial documents each time they draw from the line. Lenders might also ask for collateral, or if you have a lower credit score, you may be charged a higher interest rate. Even so, the flexibility and affordability of a line of credit outweigh the negatives for most borrowers.
A term loan is likely the first thing that comes to mind when you think of a business loan. With term loans from online lenders, you’ll typically see fixed interest rates between 7 percent and 30 percent with a maximum loan about of $500,000. These types of loans are repaid on a set schedule over a set period. Borrowers like term loans for their predictability and relatively low rates. If you decide to shop for a term loan, look into any additional fees added by the lender—including potential pre-payment penalties—to be sure you understand the real cost of the loan.
As the name implies, a short-term loan is a straightforward option like a term loan, except that you borrow the funds for a shorter length of time. Typical applicants can apply and obtain funding for between $2,500 and $250,000 in as little as two days.
Although interest rates can be quite a bit higher than with a traditional term loan, a short-term loan is a great option if you need working capital quickly and are okay making daily or weekly payments on the loan.
To help small business owners obtain the working capital they need, the U.S. Small Business Administration offers a variety of loan programs through local intermediary lenders. While the SBA itself does not fund small business loans, they offer a default guarantee that makes lenders more likely to approve small business loans than they might otherwise.
Most popular among the SBA’s loan programs is the 7(a) loan—an all-purpose term loan of up to $5 million with rates of 6 percent to 13 percent, plus fees. Although 7(a) loans may have higher than average approval requirements, the SBA’s guarantee makes these loans more accessible than a traditional bank loan while offering a similar interest rate.
If you’re just starting out and need only a minimal amount of working capital to get rolling, the SBA microloan program may be more of a fit. Microloans range from $500 to $50,000—the average loan amount is $13,000—with interest rates between 8 percent and 13 percent. You can use microloan funds for a wide variety of purposes (excluding buying real estate or paying off existing debt) and have up to six years to repay the loan.
SBA loans are typically more paperwork intensive and have a slightly longer approval timeline than other loan options. You may be asked to put up collateral with this loan type—all things to be aware of if you decide to pursue obtaining working capital through an SBA program.
If slow paying clients are the only thing standing between you and the working capital you need, invoice financing may be an ideal option. By using your invoices as collateral, you can get an advance of up to around 85 percent of your outstanding invoices in as little as one day.
Once your customers pay their invoices, you’ll receive the balance you’re due—minus the fees charged by the lender. This will likely include a processing fee of around 3 percent and a factor fee of around 1 percent per week until full payment is received.
Compared to other types of working capital for small businesses, invoice financing is more expensive. However, it is an effective way to get cash quickly if you find yourself in a pinch.
Regardless of how you go about obtaining working capital for your business, take the time to research your options, review the terms, and read the fine print to make sure you’re getting the best deal available to you. You also want to forecast your repayment and financial projections accurately, and make payments on time. When you do this, a loan option may be a good solution to keeping your working capital working for you.
Meredith Wood is the editor-in-chief at Fundera, an online marketplace for small business loans that matches business owners with the best funding providers for their business. Prior to Fundera, Meredith was the CCO at Funding Gates. She is a resident Finance Advisor on American Express OPEN Forum and an avid business writer. Her advice consistently appears on such sites as Yahoo!, Fox Business, Amex OPEN, AllBusiness, and many more.