Do the words working capital loans and credit debt make you cringe, recoil back to your safe place and stay there forever? The idea of accruing debt is not something we look forward to as business owners. BUT, working capital is important — what if your company experiences an influx of unexpected business, or alternatively, a very slow season? Working capital loans can help you pay employees and maintain rent payments without going out of business.
We want to help you get excited when you hear the words working capital… because it means infinite possibilities! There are two ways to obtain working capital: by applying for a working capital loan or for a business credit card. Both have their benefits and their downsides. This post will detail specifically the pros and cons of a working capital loan vs a credit card.
First off, what’s working capital? The technical definition of working capital is the amount of a company’s current assets subtracted by the number of its current liabilities. So what does that mean in plain English? The best way to explain is by walking through an illustrative example. Let’s say, Juan, who runs a construction company, is expecting to receive a lump payment of $200,000 from a big customer within the next 90 days. In this case, he’ll have $200,000 of current assets on his balance sheet. At the same time, he owes his workers $50,000 within the next 10 days (showing a current liability of $50,000 on his balance sheet). Although Juan significantly grew his business with the new big customer, Juan desperately needs $50,000 to pay his workers. In fact, Juan will need up to $150,000 in cash (current assets of $200,000 less $150,000 in current liabilities) to finance future payrolls and fixed costs until he receives payments from the big customer. If your current assets (e.g. outstanding customer invoices) are higher than your current liabilities (e.g. supplier or vendor invoices, payroll) you may need additional funds. You can achieve this by applying for a credit card or a working capital loan.
Still confused? Learn here all you need to know about working capital.
We’ll begin by detailing how credit cards can work for you and against you.
Business Credit Cards
I’ll go ahead and give you the bad news first…
- A high balance may lower your credit score: Keeping a high balance on a credit card can significantly lower your credit score and your possibility of getting approved for a loan in the near future. A high balance for less than 30 days is OK. In fact, it can help build your credit. Your credit score gets hurt when you use over 30% of your credit limit for over 30 days.
- Small fees that add up to big amounts: Annual fees, late payment fees, cash advance fees… all of these can sneak up on you if you don’t familiarize yourself with the terms and conditions on the credit agreement.
- Variable-rate debt: Business credit cards are unsecured loans that carry a higher APR (i.e. annual cost of the credit) than secured loans. Secured loans are those that require collateral; since the lender relies on the borrower’s assets as a guarantee in case the loan can’t be repaid, they show more flexibility on their interest rates. Unsecured loans, on the contrary, don’t require collateral, forcing lenders to raise their interest rates, in an effort to balance the risk. Depending on your personal credit score, the interest rates on unsecured business loans can range from 12% to 22%. If your interest rate is variable, it means the percentage of interest you pay off can rise at any moment.
But here’s the good news as aptly detailed on Camino’s post Use a Business Credit Card to Capitalize Your Business.
- Rewards: Nothing is better than getting positive affirmation for spending money. “Business credit cards reward you for using them, and you can adapt these rewards to the needs of your business. For example, if you travel by plane frequently, you can earn free miles. You can also get better hotel rooms and discounts when renting a car. Other benefits include discounts on fuel and refunds of up to 5 percent on purchases made in authorized stores by the card provider.” Also, some cards offer cashback for spending on things like internet and cable. If a card offers you 2% cashback and you spend $10,000 per month on your business, that’s $200 you’re getting back instead of the $0 you were getting pre-credit card era.
- Credit History: Applying for a business credit card can offer you the opportunity to fix, improve, or create your credit. When applying for a loan, credit history is a big factor, so if you haven’t established credit history and are considering applying for a loan — a credit card might be the best way to start… which brings us to the next point.
- It’s Easy: Applying for a business card is often easier than applying for a bank loan. You can skip gathering the financial statements, tax returns, and detailed business plans.
- Sign-up Bonus: Some cards will offer miles (as much as a domestic roundtrip) or cashback when you spend a certain amount in the first three months. For example, American Airlines AA Advantage Executive Card offers 75,000 bonus miles after qualifying purchases… which is good enough for a round trip to Hawaii (on low season)!
Credit cards are a great solution when used wisely. This is how credit cards work: simply use your credit cards as if it was a debit card. This will have zero cost for your card. Pay automatically your entire balance every month. If you do this, you’ll build your credit score, gain reward points and never pay interest.
Working Capital Loans
Working capital loans are defined as loans that are taken to finance the everyday operations of a company. Working capital loans are not used to purchase long-term assets (assets that are not intended to be turned into cash or consumed within one year of the balance sheet date such as property, equipment, investments, etc.) but are, instead, used to cover things like wages and rent, or company growth expenses. Companies that have high seasonality (e.g. an ice cream parlor in Chicago) usually rely on working capital loans to help with periods of reduced business activity. Companies that experience a growth spurt in a short period of time and are financially unprepared for it, might also consider applying for a working capital loan. Below, we’ll discuss the pros and cons of a working capital loan plus, we’ll detail the benefits of applying online for a working capital loan from Camino Financial.
You know how it goes, bad news first:
- High Interest: You may be charged higher interest, especially if it’s an unsecured loan (meaning you don’t have to put up collateral). This will make payments more difficult to afford and sometimes will cost a couple of thousand dollars more depending on the amount you are borrowing. But before you dismiss a loan opportunity because of the high interest, try to think in terms of the return on the investment (also called ROI). If the cost of the loan generates a positive ROI, you should consider the loan. You can read here more about what is high and what is fair when it comes to interest rates.
- You have to repay quickly: This is both a benefit and a downside — you’ll have to return the cash quicker than with other types of loans. Because working capital loans are intended to give you a quick pat on the back, there aren’t many options that provide longer payback periods. But wait! There are some exceptions. Take for example Camino Financial microloans, which are better when it comes to terms and payment installments that any other working capital loan: while most working capital loans require the borrower to repay in less than 12 months, and very frequently (daily or weekly), Camino Financial microloans are paid monthly (as a regular business loan) and in 24 months.
The good news is:
- You Don’t Have to Give up Your Stuff: Unlike some small business loans, most working capital loans don’t require you to provide assets that can vouch for you if you fail to make payments, i.e. real estate, equipment, inventory, etc. Camino Financial’s small business loan application does not require collateral. In other words, they offer unsecured business loans.
- You’re In! Getting approved for a small business loan can be more challenging than getting approved for a credit card, usually because the lending amount in the first case is often much higher… but this depends on the loan and the lender. When you submit your loan application using Camino Financial mobile-friendly app, you can find out instantly if you have been pre-approved. And you could receive your funds in 4-10 days after you submit your application.
- Cash in Hand: You’ll have the cash to address cash flow problems in your business. No need to worry about your money being in an online portal where it’s hard to access and there’s a cash fee. This is particularly beneficial for businesses who have a growth spurt and need to hire new employees or purchase new equipment. Plus, you can spend the money however you’d like — chances are your lender won’t place too much restriction on how you spend.
- You Can Get Rid of Your Debt Quick: As with any loan, you’ll have to pay back with interest. But working capital loans are designed to help you pay back quickly — within months or a year. So you won’t have to worry about working capital debt five years along the line, unless, of course, you plan for it. Also, have in mind that your debt can last less it that’s what you decide. With Camino Financial, you can repay your loan at any time with no prepayment penalties.
We hope you can now better gauge which loan is a better fit for your business. If you’re leaning towards a working capital loan due to its more beneficial aspects, consider a working capital loan from Camino Financial. The loan is intended to help the small guys, or family businesses, offering from $5,000 to $400,000 in available funding. Some other key features from Camino Financial working capital loans are:
- Instant pre-qualification with no impact on credit
- Mobile-friendly application with funding available in 4-10 days
- Repayment at any time with no penalty or additional fee
- Collateral is not required
- Few restrictions on the use of funds
- Annual interest rates from 12.0% to 29.75%
- Loan terms from 24 to 60 months, paying monthly