10 Valued Secrets – How to get a Working Capital Loan
Written by Eric info@acsecapital.com
I've been involved in business for some time and now I have decided to make a commitment to providing small businesses with truely helpful information.
How to get a Working Capital Loan
Have you ever heard the phrase money makes the World go around?
Well, If you’re thinking of how to get a working capital loan, then this is a guide about the working capital requirements of an Enterprise or Small business.
Not uncommon for businesses to work out there working capital needs before they borrow. Sometimes its good to just enquire about standard Term Loans.
It’s very important to ensure that you get the right financing for your business first before entering into agreements with your clients or even suppliers.
Ultimately, the items below help with answering in quick and straightforward clarity exactly what you will need to have prepared to answer the question of how to get a working capital loan.
- 6 to 12 months of financials.
- Be in business for 6 months to 1 year.
- Be Cash flow positive or have cash flow of approximately $10,000 dollars a month plus. (Though it would be case by case).
- Proof of business ownership.
- Identification, usually a drivers permit for an easy background check.
- SSN / EIN / ITIN dependant on the nature of the business entity.
- Forecast and Budget (dependent on the type of lender).
- Full business plan and in some cases a summary business plan.
- 2 to 3 years tax returns (dependant on the lender and size of the loan).
- 3 years or more of financials from a credible source (Quickbooks, Xero, Freshbooks, Accountant, etc).
Here is an illustration of what we’ve used in the past when we did things manually
“Usually 100% ownership otherwise the remaining shareholders may be called upon to be part of the application if they have controlling interest in the company.
Anything less than $100,000 I am seeing has more flexibility on any collateral.
Above $100,000 usually requires some form of collateral.”
Let’s take a look at how to get a Working Capital Loan and put it into perspective.
- The definition of working capital is current assets minus current liabilities. Having cash in the bank is not enough. What are your current assets, they are made up of, cash in the bank, current accounts receivable and your inventory. Therefore a working capital loan takes into consideration how to get the quantified value of what is needed to operate the business.
- Current liabilities is defined as your current accounts payable any long-term payable your company may have. For example, small business loans, lines of credit, merchant cash advance, revenue-based lending and invoice factoring. This assessment takes into account how future payments or monetary obligations would affect the ability of the business to service the debt in a timely fashion.
- You divide your current liabilities into your current assets. You’ll come up with the ratio of assets to liabilities. Your objective should be to shoot for twice as many assets as you have liabilities or a reasonable two-to-one ratio. It is challenging for many businesses but anything below a one-to-one ratio is a red alert warning to lenders that you have negative working capital even if you have cash in the bank at the end of the month. In a nutshell you working capital loan should not put you in a position where you are not at least breaking even which is most times governed by your DSCR (Debt Service Coverage Ratio), typically 1.5x.
“Have a look at this great video from Tim Bennett breaking down Working Capital into digestible chunks of information”
How does this impact a Small Business?
- Many small businesses should consider looking at it in this way. The average number of days it takes your inventory to turn over and your time frame in which to pay for that inventory under the average number of days for you to receive payment from your customers, which is typically considered to be an item called Aging. If you are having issues with receiving payments or conversely if you’re having issues getting inventory off the shelves, this would indicate that your working capital needs are out of cash flow.
- It is very important for businesses to pay attention to their payment terms just as much as they pay attention to account receivables and accounts payables. The intent should be to maintain a one-to-one ratio with the goal of a 2 to 1 ratio. For many small businesses it’s definitely a struggle to maintain their working capital needs with account receivables alone. It is very common for small businesses to seek financing to meet the shortfall. Keep in mind that any financing used to meet the shortfall then becomes a liability which would have to be included in your ratio.
- Therefore, it’s very important that you don’t make your business unprofitable by borrowing unnecessarily. What is important is that you carefully identify your operational expenditure and any ancillary spending needs, to assess exactly how much cash on hand is needed to sustain your business for at least 3 to 6 months, which can vary widely from business-to-business.
- Many experts advise that you only borrow working capital to increase the value of your business or to capture additional return on investment. Despite the accounting jargon, you’re probably asking yourself, how would I know if I need a working capital loan or how to get one? The simple answer to that is there must be good record-keeping in the form of maintaining your books and for many businesses this might be difficult to do in the hustle and bustle of things, not to mention the new economic environment that we are unfortunately in, But at the end of the day business must go on because opportunity waits on no one.
- If possible you should plan as far into the future as you can, usually called forecasting. Some businesses borrow funds to meet their salary expenses, inventory expenses, cash on hand needs and more. Before you agree to any loan make sure that you have the cash flow to support the periodic payments, especially if it causes you to go into a negative ratio.
I’m sure most of you have heard about Invoice Financing but there are several other methods of obtaining financing, “AKA” Working Capital for your business.
- Trade Credit is one of those methods. If you are on good credit terms and have a good relationship with your vendors and suppliers, it is possible to negotiate payment terms because suppliers are often open to working with their best customers when they need to fill a large order or to ramp up a new contract or just bridge a short-term gap for additional working capital by extending payment terms to your business and in some cases to you directly based on your personal credit score and whether you are a 1099 contractor.
- Short Term Business Loans is another option which can range from 3 to 12 months or more and could be a good option for financing a small business working capital loan depending on your credit profile and the industry, along with the overall health of your business can provide you with more than one option.
- Business Line of Credit which are typically more difficult to qualify for than a traditional business loan. But if you can qualify it offers the opportunity for your business to have access to a revolving credit facility. This is credit you use when you need it, you pay interest on the amount of credit that you use. You pay off your balance then you reuse it again.
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