4. Choosing a Working Capital Loan | SME Guides
BY KIMBERLY SIEW – AUGUST 19, 2019 – 5 MINS READ
Which working capital loan is right for your small business? Working your way through a checklist can help you better determine the best financing solution for your needs. While an SME working capital loan might carry a higher interest rate, that shouldn’t be a deal-breaker. There are other considerations you’ll want to make in choosing a working capital loan for your business!
- What is working capital?
- When to get a working capital loan
- Types of working capital loans
- Choosing a working capital loan
Below are some questions to include in your list:
How quickly do I require funding?
Depending on your loan purpose, you may or may not be able to wait for several weeks to gain access to funding— as is the case for situations such as urgent equipment repairs, or when you require external financing to fund a large scale business project.
In these scenarios, traditional lenders may not be a good fit. It is because these lenders tend to have rigorous application processes and lengthier onboarding periods. It’s common for businesses to have to wait several weeks to hear back about the status of their loan application.
Will the loan improve my business’ financial position?
Certain types of financing solutions, such as merchant cash advances carry hefty fees and may require daily repayments. As such, things may quickly spiral out of control if owners aren’t able to keep up with the payments. They may wind up in a debt spiral, taking out multiple loans in succession in order to pay off the outstanding balance on previous advances.
Before you commit to a loan, you need to be absolutely sure that you’ll be able to meet the repayments in a timely manner— and that the benefits it brings to your business outweighs the costs.
Do I understand the real cost of the loan?
As with any kind of business loan you choose to take up, it’s essential that you pay close attention to the repayment terms, and fully understand all possible fees you may be liable for.
The interest rate for an SME working capital loan is typically higher to account for higher chances of default. Always request for a full breakdown of the fees involved, and keep an eye out for terms that allow for changes in the interest rate, as well as loan acceleration clauses.
What’s the ROI of the loan?
While obtaining external financing can be key for growth, it may not be a good fit for your business depending on your current situation and financing needs. “Will borrowing earn me more money than it costs?” is an important question you’ll need to answer to assess the ROI of the loan.
Ideally, you should be using the funds obtained for investments or activities that will produce growth or revenue, or create a significant reduction in your costs— such as inventory purchases or equipment repairs— and not expenses like office renovations, as these will produce a negative ROI.
What are my short-term vs long-term needs?
Lastly, it’s important not to confuse your business’ short-term working capital needs with longer-term financing requirements.
Simply put, working capital is used to pay off short term obligations. Long term financing requirements are related to investments. Activities that impact upon the long term growth of your company such as major renovations, expansion to a new location or equipment purchases. Distinguishing between these two types of financing needs is key, so as to avoid running into problems that may arise from choosing financing solutions that aren’t a good fit for your needs.
Here’s an example:
A line of credit is best suited for short term financing needs, due to the flexibility it offers. Business owners can draw from the line at anytime without restrictions imposed on what the funds can be used for. However, if a borrower were to use up the line for longer term expenses, this will limit his or her access to financing should urgent expenses arise out of the blue.
- Working capital loans are designed for short term financing needs. Small business owners typically obtain these loans to capitalise on time-sensitive business opportunities, manage seasonal fluctuations or to create a cash cushion.
- Common types of working capital loans include: short term loans, invoice financing, business lines of credit and merchant cash advances.
- Running through a checklist of essential pointers is critical for helping you evaluate loan options that will best meet your needs. Some key questions you’ll need to ask yourself include: “How quickly do I require funding? What’s the ROI of the loan?”
We hope Aspire’s SME Guide to working capital loans has helped you understand the financing options for your small business. If you have any other questions, we’ll be happy to hear from you! Contact us at +65 96196929 to find out more.