Working Capital Loan vs Term Loan
This article discusses working capital loans and term loans. Both loans are used to increase your cash flow and revenue, but each loan is good for a different type of expense. Applicants have to determine whether the expense in question is needed for survival, or if it is needed as a growth opportunity. In addition, the applicant must understand how quickly the loan will be paid off.
In this article we’ll discuss
- What is a working capital loan.
- What is a term loan.
- When to use a working capital loan.
- When to use a term loan.
Working capital loan
This is a short term loan. It’s a business loan, which means it must be paid back in 2-6 months. It’s main objective is to cover your day to day operation expenses, and regular expenses. The amount you are provided is for the cost of running your business. Typically, the interest rates are higher than average on the loan, since the amount of the loan can be just a few thousand dollars if needed. As long as you pay the loan back on time – the working capital loan can be taken out as many times as you need. It is very effective.
This is a loan which is paid back over the course of 1-5 years. This type of loan is designed to cover any expensive investment you make, which will increase revenue over time. It is a long term loan. The amount which you borrow should be based on your return on investment projection. As a result, many businesses can qualify for a term loan as little $50,000 to as much as $5,000,000. There are a few things you need to think about when it comes to term loans. You need to think about the payment methods, whether collateral is being requested, and whether te interest rate is fixed, or depends on the lender.
What should you do?
Working capital loans should be used to keep a company alive and afloat. You should only take out a working capital loan if you need to make immediate payments, or need to make some sort of time sensitive payment. You should only take out a term loan if you intend to increase revenue over time, and can repay the debt. If you use a business loan solely to pay your bills, without increasing revenue – what happens when the loan runs out? Working capital loans are only meant to cover the cost of business because the funds you would NORMALLY use are being used elsewhere. That means it’s critical you urgently stabilize your incoming revenue and adjust your business.
Say you run a restaurant, and your laying out money for a new order of inventory. A working capital loan lets you pay for this order. It’s likely you’ll sell the inventory in your restaurant so you can repay the loan you took fast. Or, another example is to pay for payroll – because you used all of your money on the inventory you bought. Bottom line, a working capital loan gives you breathing room.
Another situation where a working capital loan is great is when you are in a seasonal business. Some businesses are seasonal, and there are increases or decreases in sales during different times of the year. If your business does better in the holidays, and you need to hire more staff – a working capital loan is better than a term loan. You can ramp up advertising and hire more staff during the holiday, and then when you make money, repay it at the end of the holiday.
Some investment opportunities take time to pay off. That’s when a term loan is great. Payments are lower than a standard working capital loan. Payments for the term loan can be offset by the boost in revenue you generate by the investment. The investment can be buying new equipment, hiring new sales staff, doing a marketing campaign, or buying additional property. While a working capital loan is designed for minor expenses and temporary timeframes, a term loan is tailored for huge expenses which are paid for over a period of years. You should only take a term loan if your business is ready to move to the next level and needs funding to do it.
Term loans can result in a large boost in your business credit score than a working capital loan. Even if you repay it back on time, taking out multiple working capital loans can harm your credit. In contrast, a term loan – if repaid, can help build your credit history with lenders. If you borrow and repay the term loan, it’ll give you the ability to get a larger term in the future with better terms.
How Delancey Street can help
Delancey Street provides creative financing. When people come to us with their challenge, we provide solutions. Traditional lenders require collateral, and a high credit score. We judge you exclusively based on your business, and it’s performance. If you need a second opinion, or if you’re getting denied by traditional lenders, we encourage you to contact us. We can customize the loan to your needs, and customize the interest and term of the loan by taking into account more factors. We look at your company – not variables like credit score. Regardless of whether you need a term loan, or a working capital loan, we can help.
We hope this article about term loans vs working capital loans helped educate you.