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HomeFinanceWhat are Working Capital Loans and how do they Work?

What are Working Capital Loans and how do they Work?

A working capital loan is essentially a cash flow loan — some finances to help pay for everyday operations. Thus, this isn’t the sort of financing that would be suitable for purchasing long-term assets or investing in new equipment. It’s no surprise that working capital loans are so popular, because cash flow is considered to be one of the greatest threats to small businesses.

 

Short term working finance is super quick, too. Small companies often have very little cash reserves, so any unforeseen costs can tip them over the edge. These come thick and fast, so the speed of receiving the money becomes the number one priority, even before the APR in most circumstances.

 

The APR is expected to be high because these loans aren’t intended for a long-term loan, so it matters less. Further, the companies who are asking for them aren’t always in the best position for a loan, and they may not be able to provide security. Instead of getting rejected or taking 3 months to assess their suitability, business model and credit worthiness like banks traditionally have, there are companies filling this demand to offer versatile, forgiving loans.

 

In the past ten years, technology has allowed this market to reach new heights — there are thousands of these companies around. Of course, some are better than others, but a quick Google search will help find the highest rated ones with good reviews to assure their credibility.

 

We can take the example of PayPal working capital. This is a clever one because the service itself is actually integrated into PayPal itself, the hugely common e-wallet in which businesses receive their sales money. PayPal actually bases the maximum amount they will loan you on the amount of PayPal sales you have and your account history. Once approved, you get the funds in minutes.

 

PayPal has an advantage here, because they can literally see your account history. They can assess your risk very well without even needing to perform credit checks and such. Other working capital providers will instead look at your financial statements, bank transactions, accounts receivables and/or credit card transactions.

 

The PayPal Working Capital has a very simple pricing method — it’s just one fixed fee. The luxury of this loan, and many others like it, is that you only repay when you make sales. If on day 1 you received $1,000 in sales, then 20% goes to the repayment ($200) and the 80% is yours to keep. Thus, if on day 2 there’s no sales, your repayment is suspended until the next time you make sales.

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This kind of integration into the platform many are likely already using is extremely convenient, and it means your eligibility is judged on pure meritocracy and performance as opposed to previous, unclear, dubious credit checks. The fixed fee also makes business owners feel reassured, as it's easy to calculate and they don’t have to worry about a high APR racking up huge repayments over a longer than expected time period.

 

Again, it’s worth restating that PayPal is far from the only company offering such technologically adept working capital loans. It’s necessary to scan the market yourself and see which suits the needs of your business. PayPal claims they have high demand at the moment too, which is delaying applications.

Working capital financing may or may not be suitable for your business during the difficult times of lockdown, but it’s a great alternative when looking for urgent money (when done responsibly). Before applying though, it’s vital to apply for all appropriate government Coronavirus schemes because you may be entitled to grant funding which is non-repayable.

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