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Supplementing Working Capital with a Working Capital Line of Credit

Working Capital Line of Credit

New York City startup Elysium Health is typical of the kinds of companies that secure a working capital line of credit.

In June 2017, Elysium Health, a developer of dietary supplements, gained a $5 million line of credit from Silicon Valley Bank to finance everyday business expenses and fuel company growth.

As described by Arbor Financial Credit Union (AFCU) in Kalamazoo, Michigan, a working capital line of credit like the one taken out by Elysium Health is similar to a credit card: It lets a business tap into a pool of money to cover day-to-day operating costs. However, AFCU says, a working capital line of credit frequently provides a lower interest rate than a credit card does.

How to Use a Working Capital Line of Credit

A working capital line of credit lets a business maintain a steady cash flow, according to Allied Financial Corp., an Atlanta-based provider of alternative business financing. That cash can come in especially handy if a business experiences seasonal ups and downs—like a ski resort or a toy shop, for instance.

“Without thinking through your cash flow, you could set your business up for failure,” AFCU warns.

Generally speaking, a line of credit for working capital enables a business to meet short-term financial needs, such as payroll, supplier payments, and utility bills, according to AFCU. It’s not designed to cover longer-term expenses, such as purchases of real estate or equipment. says some businesses open a working capital line of credit before they need cash in case an emergency arises, while other businesses might keep a line of credit open to take advantage of a one-time bulk discount being offered by a supplier.

How Does a Working Capital Line of Credit Work?

In most cases, short-term assets like accounts receivable or inventory secure a line of credit for working capital, AFCU says. Under this line of credit, a business normally can borrow up to 80 percent of the outstanding accounts that are less than 90 days old.

AFCU offers this example: If a business has outstanding receivables of $100,000 that are less than 90 days old, it could borrow as much as $80,000, or the maximum allowed in that scenario.

Under most circumstances, the term of a working capital line of credit is 12 months, AFCU says, and you might be required to renew or pay off the loan once the 12-month period ends.

AFCU touts the flexibility of a line of credit for working capital, as it allows a business to take advantage of available cash whenever the need comes up. As a rule, it’s also less costly than a business credit card and offers higher credit limits, the credit union says.

“The major advantage of this type of financing is that the debtor is only charged interest on borrowed funds and not the maximum loan amount,” says Alternative Funding Partners, a Denver-based commercial loan broker.

Types of Lines of Credit to Use as Working Capital

Two varieties of lines of credit are available for working capital: secured and unsecured.

An array of businesses can benefit from either a secured or unsecured working capital line of credit. For instance, a startup might need quick access to cash, while an established company might be adding a new line of business. In either instance, a working capital line of credit can serve as a financial lifeline.

“You can’t always control when your customers pay or when expenses are due, but you can fully control your credit line. Having working capital financing available will free you up to focus on growing your business without worrying about every big change in inventory or cash,” says Gusto, a San Francisco-based provider of payroll, benefits, and HR services for small businesses.

Secured Business Line of Credit

A secured business line of credit traditionally offers a higher credit limit and lower interest rate than an unsecured line of credit does, according to Arch Capital Solutions, a Naples, Florida-based provider of business financing.

With a secured business line of credit, a lender will extend a loan only to a business that has assets, Arch Capital says. During the entire term of the loan, the lender puts in place a lien against the collateral so it can recover money in case the borrower fails to make loan payments.

Among the kinds of collateral that a lender will accept for a secured line of credit are accounts receivable, machinery, inventory, cash, CDs, securities, and real estate, according to Commercial Capital, a business finance company with U.S. headquarters in Miami. Both business and personal collateral can be used.

Unsecured Business Line of Credit

An unsecured business line of credit does not require collateral. As such, its credit limits tend to be lower and its interest rates tend to be higher than a secured line of credit. Most unsecured lines of credit are guaranteed by the company as well as the owner, Commercial Capital says.

Those guarantees enable the lender to sue the business and the business owner if they default on the loan, according to Commercial Capital. If the lender wins the case, then it could foreclose on the assets of both the business and the owner.

Working Capital Line of Credit vs. Loan

Don’t confuse a working capital line of credit with a working capital loan. They’re not the same thing.

Like a credit card, a working capital line of credit is a revolving account, according to United Capital Source, a small business lender based in New York City. This means you’ve got a pot of money, so to speak, that you can reach into whenever your business needs cash. The pot of money isn’t bottomless, though. The lender caps the amount of money you can pull out—for instance, $1 million.

“As you repay, more of the ‘kitty’ becomes available to use again,” United Capital Source says.

That’s where the “revolving” part comes in. A business can regularly renew the line of credit, or can cut off the supply of cash at the end of a certain period, such as two years. If a business picks the second option, it can renew the line of credit as long as it still qualifies, according to United Capital Source.

A line of credit is normally unsecured. That’s why a business with bad credit or poor management of cash flow might not qualify for a line of credit, United Capital Source says.

Therefore, the best time to apply for a line of credit is when the business is doing well, not when it’s experiencing a cash crunch, according to United Capital Source.

Like a line of credit, a working capital loan normally goes toward short-term business needs, such as payroll or accounts receivable, according to Investopedia. Companies that undergo seasonal swings in business, such as manufacturers and retailers, are prime candidates for these loans.

“The immediate benefit of a working capital loan is that it’s quick and lets business owners efficiently cover any gaps in working capital expenditures,” Investopedia says.

The money from a working capital loan comes in one lump sum, and the loan is paid off over a set period of time, anywhere from a few months to a few years.

Keep in mind that a working capital loan, which can be secured or unsecured, usually carries a higher interest rate than a traditional small business loan does. In addition, an unsecured working capital loan can jeopardize the business or the business owner’s personal finances if something goes wrong.

United Capital Source says the application process for a working capital loan is simpler than the process for a traditional business loan. Plus, it’s easier to qualify for a working capital loan, and a business often can access the money within a few days.


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