Working capital loans are a great boon to small businesses that don’t have the upfront funding. There are a variety of ways to raise that money, from 401(k) financing to crowdfunding.
What is a working capital loan, then?
It’s a short-term loan from your bank or alternative lender to pay start-up costs and grow your business. Buying inventory, securing an office location, hiring employees—it all costs money, and a working capital loan can help you pay those costs. The key phrase here is “short-term.” These loans aren’t for achieving lofty goals in the future.
Let’s look at a few different tips for how to secure working capital for your business and start your business on financially solid ground.
Build Solid Credit
If you’re taking out a loan in your business’s name, lenders want to see a good credit history that proves you can pay off your debt in a timely manner. For start-up businesses, this can be a tricky venture. Your small business doesn’t have two years of credit history that lenders often require before giving you a loan. Start-up loans often take longer to approve and are more difficult to achieve—but not impossible.
As an individual, you should also maintain your own credit. Before applying for your small business loan, pay off any outstanding debts. If your credit report looks wrong to you, address any inaccuracies. If you have ever gone bankrupt, be prepared to explain the circumstances of that bankruptcy to your lender.
Have a Strong Business Plan
All the preliminary steps you take before applying for the loan help you make a good impression on your bank or alternative lender. They want to see that your business will turn a profit. While they may not maintain interest in your day-to-day office operations, they do care about that bottom line. They want to know that you will be able to pay off your loan.
Prove to your lender that your business will be a success. Detail where your start-up funds will go and how that money will help your business flourish. While you may have goals for a bright future, be realistic about them.
Ideally, your bank or lender will see that their loan will lead to significant growth. They want to rest assured that the success of your business plan will help you pay off your loan quickly.
Pore Over Your Finances
How much start-up capital are you asking for? Get a better idea of your ideal loan amount by understanding your business’s short-term financial standing.
A working capital ratio is an easy way to visualize the current health of your business. To calculate your working capital ratio, divide your current assets by your current liabilities. If you have $10,000 in assets and $5,000 in liabilities, that ratio is 2:1. It’s a pretty healthy ratio that lenders like to see.
Now let’s calculate your net working capital. This is another easy equation: subtract your current liabilities from your current assets. Based on the example above, your net working capital would be $5,000.
Only use your short-term assets and liabilities to make these calculations. You’ll have a better idea of how your business’s finances work. As you grow, pay attention to seasonality as well. If your business depends on the changing of seasons, like landscaping or even bridal photography, your belt may be tighter some months than others.
Know Your Options
There are a few different ways to secure working capital for your small business, from venture capital firms to business credit cards. Let’s take a quick look at the most popular options.
SBA (Small Business Administration) loans don’t go directly through their organization. They secure bank loans for businesses with solid credit and a good financial history. The SBA 7(a) loan is one of the most affordable ones out there, but the requirements can be harder to meet.
Another simple loan option is a business credit card. They work much like personal credit cards do: that little piece of plastic allows you to spend money up to a certain limit. Business credit cards are much easier to qualify for than other types of loans, but they also take into account your personal credit history. Come tax season, you’ll have to prove that your personal and business expenses are completely separate.
If you are currently an employee of a big company and looking to start a business of your own, you may have a 401(k) you can finance. 401(k) small business financing often involves rolling your existing retirement funds into a new 401(k) plan specifically for your business. This way, you can avoid extra taxes and withdrawal penalties.
Other ways to accrue start-up capital for your business include crowdfunding and seeking out venture capital firms. One relies on donations and the goodwill of your loved ones, while the other involves dealing with investors and having a board of trustees.
Prove Your Success
Once you’ve secured your working capital, whether through an SBA 7(a) business loan or venture capital firms, engage in smart business practices. Show off what a prudent business owner you are and how responsible you are with your loan.
Pay close attention to your financials and set up an accounting department to manage the movement of that money. Make sure your customers pay you on time and ensure you pay your own expenses on time. Late payments and messy books don’t look good on your credit report.
When you take out a loan, review the repayment term with your lender. When you are approved for a business credit card, use it solely for business expenses. If any of your accounts aren’t turning a profit, trim the fat without cutting corners. Your financial responsibility now will allow you to borrow more money in the future, should you need it.
Starting your own business can be thrilling and nerve-wracking. Luckily, you don’t need to shoulder the entire burden yourself. Plenty of lenders and potential investors want to help small businesses grow, so develop a good working relationship with your lender. Of all the ways to secure working capital for your business, there’s a perfect option for you somewhere. Know your options and be prudent with the choices you make.