Most small businesses need some form of working capital loan or financing at one time or another. They use these loans to handle short-term financing needs, such as making payroll, paying vendors, or starting a new project. Basically, the funds are used to run the business and grow.
Working capital financing options
Many small businesses encounter problems when looking for working capital. This difficulty is due, in part, to the fact that they often look at the wrong options.
In this article, we discuss five working capital loan options that are available for small businesses – even startups. Some options, such as bank lines of credit, can be used for any purposes but are hard to get. Other solutions, such as factoring or purchase order financing, are more specialized in their use but are significantly easier to get.
#1 Invoice factoring
This solution helps companies that need working capital because their clients pay invoices in 30 to 90 days. Slow invoice payments are common when selling products and services to large commercial clients. Unfortunately, many small business owners can’t afford slow payments and need to get paid sooner so they can pay their own expenses.
You can solve this problem by factoring your invoices, which improves your cash flow immediately. While not technically a loan, factoring financing provides an advance for slow-paying invoices. This advance improves your cash flow and provides the working capital you need to pay current expenses, take on new clients, or grow your business. Learn more about factoring invoices.
#2 Purchase order financing
This solution helps distributors and re-sellers that need funds to pay their supplier expenses. For small companies, getting a “large order” can be a problem as well as an opportunity. Large orders often have high fulfillment costs which use up all your resources. Or worse, your small business may not have enough resources to complete the order and may have to pass on it.
The best way to handle this working capital problem is to use purchase order financing. This solution provides funding to cover the direct vendor expenses associated with a specific purchase order. It enables you to fulfill large orders and grow your company beyond its current capitalization. Learn more about purchase order financing.
#3 Asset based lending
Small companies often have their cash resources tied to certain assets such as accounts receivable and inventory. An asset based lending facility allows you to finance those assets. This solution provides you with working capital to pay for corporate expenses and new investments.
Asset based financing facilities are often used by mid-sized companies that have outgrown their factoring financing lines but can’t get a conventional line of credit. The line operates as a revolving financing facility that adjusts to your available assets.
Learn more about asset based lending.
The Small Business Administration (SBA) has a business financing program specifically for small businesses. The lines have a maximum of $50,000, and the funds can be used for most business expenses – from startup to expansion.
Unlike conventional loans, Microloans have relatively easy qualification criteria. They often come bundled with business training from the SBA, which makes them attractive to small businesses. Learn more about SBA Microloans.
#5 Conventional bank financing
Lastly, small businesses can solve their working capital problems using conventional bank financing – business loans and lines of credit. Lines of credit offer great flexibility at a low price. The only challenge with bank solutions is that qualifying for them is fairly difficult, especially for small businesses.
To qualify for conventional bank financing, your company needs to have a track record of growth, spotless financial statements, a good management team, and substantial assets. If your small business meets these criteria, bank financing is often the most cost-effective solution.
Selecting the best alternative for your small business
Selecting the best option for your company depends on why you need the funds, whether your company is new or established, and your track record.
Generally, small companies that have working capital problems due to slow-paying customers should consider a Microloan or factoring. Larger companies should consider an asset based lending facility.
On the other hand, companies that have working capital problems due to large orders will be better served by using purchase order financing. Purchase order financing lines are often used alongside a factoring facility (or asset based lending) because combining both products reduces transaction costs.
Lastly, if your company has a strong balance sheet, spotless financials, and track record of profitability, consider a working capital line of credit. These bank facilities are attractively priced and can be ideal for small and growing companies.
Looking for working capital financing?
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