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What are Working Capital Loans?

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  • Written By: Malcolm Tatum
  • Edited By: Bronwyn Harris
  • Last Modified Date: 27 October 2016
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Working capital loans are short-term loan arrangements that provide businesses with day to day expenses associated with the operation. They are not intended to function as a means of securing the funds needed to purchase long term assets or to make investments. Instead, the proceeds from working capital loans are intended for use in paying items currently pending in the accounts payable, providing employees with wages, or other basics common to most business operations.

There are several different options when it comes to working capital loans. One common approach is known as a micro loan. This option normally requires very little time to arrange, especially if the company in question is established and shows every indication of remaining a viable entity. A loan of this type is ideal when there is a short-term reduction in accounts receivable, such as with businesses that are somewhat seasonal. The amount of the loan can allow the business to continue functioning during the slow season, then settle the balance due on the loan once sales pick up during more prosperous seasons in the business year.

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One example of working capital loans that has become increasingly popular is the factor loan. This approach involves establishing an ongoing working relationship with a finance company that essentially purchases the weekly or monthly accounts receivables of the business. The factoring company assesses the invoices issued during the period under consideration, then advances the business a percentage of the total value of those invoices, usually eighty percent. Customers remit payment for those invoices directly to the factoring company, who credits those payments to the business. Once all the invoices for a given period are cleared, the factoring company issues most of the remaining face value of those invoices to the business, retaining anywhere from three to five percent as their fee for providing the service.

Some banks also offer various types of working capital loans that are essentially signature loans. Often, these loans may be for no more than one or two months, and are structured to require one balloon payment to be received on a specific date in the future. While this approach can be extremely helpful during a short-term cash crunch, the interest rates for this type of service may be a little higher than other options.

With most working capital loans, paying close attention to the terms and conditions, and making sure there is nothing that may cause issues later on are both extremely essential. For example, if a business is considering looking into working with a factoring company, make sure that the collections strategies employed by the company are in keeping with the culture of the business. Failure to do so could lead to unpleasant situations with customers, and ultimately cost the business ongoing business from those customers, creating additional financial problems down the road.

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