SoFi

One of the biggest challenges in taking out a small business loan is figuring out which loans to apply for. The Small Business Administration (SBA) offers a variety of financing opportunities for small businesses that might not be approved for other types of loans.

When you compare SBA loans to conventional business loans, you’ll see that the former typically have more competitive rates and terms because the federal government guarantees a portion of the loan funds.

However, there are significant differences even within the SBA loan category. Here, we’ll look at two popular SBA loan programs: the 504 and 7(a) loans. Both offer high maximum loan amounts, but they vary regarding how you apply and how you can use the loan funds.

SBA 504 vs. 7a Loans

What Is an SBA 504 Loan?

An SBA 504 loan provides financing for small businesses to fuel job growth in their local communities. Loans are available up to $5 million. The application process is unique because it goes through a certified development corporation (CDC).

A CDC is an SBA-approved organization that provides 40% of the loan from SBA funds and then sells 50% of the loan to a third-party financial institution. The borrower provides the remaining 10% for the project.

Key Features and Terms

504 loan interest rates are low compared to other types of financing. Repayment terms can last 10 years, 20 years, or 25 years. Eligible uses for the funds include:

•   Purchasing or constructing buildings, new facilities, or equipment

•   Improving or modernizing existing facilities, land, streets, or parking lots

Borrowers may not use 504 loans for inventory, working capital, or debt consolidation.

Recommended: SBA Loan Requirements

What Is a 7(a) Loan?

SBA 7(a) loans are the most common type of SBA loans. The maximum loan amount is $5 million, and the funds may be used for a broad range of purposes, including:

•   Real estate

•   Working capital

•   Debt refinancing

•   Purchase of supplies, furniture, and fixtures

Program Overview and Terms

Real estate loan repayment can extend as long as 25 years, while all other 7(a) loans last up to 10 years.

The SBA guarantees the majority of the loan, but you apply for it directly with a lender. The loan approval process typically speeds up if you choose an SBA Preferred Lender, because these lenders have a positive history processing SBA loans.

In addition to the standard 7(a) loan, there are other types available as well:

•   7(a) Small Loan

•   SBA Express

•   Export Express

•   Export Working Capital

•   International Trade

•   CAPLines

💡 Recommended: SBA Loan Calculator

Main Differences Between SBA 504 Loans and 7(a) Loans

504 loans and 7(a) loans are two very distinct programs. It’s wise to understand the differences before you start the application process.

Use of Funds

Regarding how funds may be spent, 504 loans focus on job creation, while 7(a) loans are tailored for expanding business operations. With a 504 loan, you can use the funds for significant expenditures, such as purchasing new buildings, land, or facilities. Alternatively, you can improve existing property. And 504 funds may also be used to buy heavy equipment and machinery.

A 7(a) loan may be used more broadly. Businesses may still purchase real estate and equipment with these funds. However, the loan may also be used for working capital, inventory, and more.

Application Process

The application process for 7(a) differs significantly from that for 504 loans. A private lender originates a 7(a) loan. You may opt to work with an SBA-preferred lender to expedite the process.

A 504 loan, on the other hand, requires you to apply through an SBA-certified CDC. These community organizations specialize in economic development.

Recommended: Business line of credit

Fees and Down Payments for SBA 504 Loans and 7(a) Loans

The SBA requires a guarantee fee on all loans, which is charged on the portion of the loan guaranteed by the federal government. You may also be charged lender fees and a down payment.

SBA 504 Loans

•   Down payment: The borrower must supply 10% of the loan amount as equity. An additional 5% is required for startups and/or loans for special-use property (such as a church, school, hospital, museum, etc.). Forty percent of the loan goes through the CDC using SBA funds, and 50% comes from a lender.

•   SBA Guarantee Fee: Currently set at 0.5% for the lender portion of the loan, plus up to 1.5% for the CDC portion. Ongoing fees may also apply.

7(a) Loans

•   Down payment: The borrower must make a 10% down payment.

•   SBA Guarantee Fee: Depending on your loan’s size, it ranges from 0.52% to 3.75% on the lender portion.

SBA 504 vs. SBA 7(a) Loan: What’s Right for Your Business?

Choosing between an SBA 504 loan and a 7(a) loan may largely depend on how you plan to use the funds.

When You Might Consider an SBA 504 Loan

A 504 loan should be used to expand or improve your business in a way that aids job growth. Because you apply through a CDC specializing in economic development, prepare to craft a business plan demonstrating this impact. Buildings, land, and facilities can be purchased or modernized with 504 funds. Long-term machinery and equipment are also considered eligible expenses. A 504 loan might be a good choice if these guidelines align with your intentions.

However, remember you’re not allowed to use the funds for debt consolidation, inventory, or working capital. While those might help grow your business, they likely won’t substantially benefit the local workforce.

When You Might Consider an SBA 7(a) Loan

There are far fewer restrictions on using 7(a) loan funds. For instance, eligible expenses include short-term and long-term working capital, making 7(a) loans preferable if you want to expand a business. Still, your plans won’t meet the 504 job creation requirements. A 7(a) loan can also be used to acquire a new business or purchase real estate for your company.

The Takeaway

Take the time to evaluate all of your business’s financing options. As you examine SBA loan requirements and consider your needs, you may decide that neither a 7(a) nor a 504 is right for you.

To get an idea of all your small business loan options or to apply for a small business loan online, check out Lantern by SoFi. Use its fast online search for a personalized small business option in minutes.

If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.

FAQ

What’s the difference between the 504 and 7(a) SBA loans?

There are several differences. First, the application process is different. With a 504 loan, you apply through a certified development corporation (CDC). SBA 7(a) loans go through regular business lenders.

There are also differences in how you may use the funds. Acceptable uses for 504 loans are more restrictive, and you must demonstrate job creation. They’re usually used to purchase or improve major assets like property or machinery. However, 7(a) loans have a broader range of uses and may also be used for working capital, inventory, and debt consolidation.

Is an SBA Express loan a 7(a) loan?

Yes, SBA Express loans are 7(a) loans. This program has a lower maximum loan amount ($350,000) but offers a fast approval time of just 36 hours.

Which SBA loan is better for purchasing real estate or equipment?

If you’re looking to purchase commercial real estate or heavy machinery/equipment, the SBA 504 loan is typically seen as the best choice.

Can a business apply for both SBA 504 and 7(a) loans?

If you have strong credit and a stellar business, the SBA and your lender might be fine with you combining 7(a) and 504 loans.

Photo credit: iStock/Prostock-Studio

SoFi's marketplace is owned and operated by SoFi Lending Corp.
Advertising Disclosures: The preliminary options presented on this site are from lenders and providers that pay SoFi compensation for marketing their products and services. This affects whether a product or service is presented on this site. SoFi does not include all products and services in the market. All rates, terms, and conditions vary by provider. See SoFi Lending Corp. licensing information below.

This content is provided for informational and educational purposes only and should not be construed as financial advice.

This article is not intended to be legal advice. Please consult an attorney for advice.

Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

External Websites: The information and analysis provided through hyperlinks to third-party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.
SoFi receives compensation in the event you obtain a loan, financial product, or service through SoFi’s marketplace. This webpage is owned and operated by SoFi Lending Corp., licensed by the Department of Financial Protection and Innovation under the California Financing Law, license number 6054612; NMLS number 1121636. ((www.nmlsconsumeraccess.org)). This page is NOT operated by SoFi Bank. Loans, financial products, and services may not be available in all states. All loan terms, including interest rate, and Annual Percentage Rate (APR), and monthly payments shown through SoFi’s marketplace are from providers and are estimates based upon the limited information you provided and are for informational purposes only. All rates, fees, and terms are presented without guarantee and are subject to change pursuant to each provider’s discretion. The actual loan terms you receive, including APR, will depend on the provider you select, their underwriting criteria, and your personal financial factors. The loan terms and rates presented are provided by the providers and not by SoFi Lending Corp. Please review each provider’s Terms and Conditions for additional details.

*Small Business Loans: Reference to “same day funding” or “funding within 24 hours” describes a general capability of many lenders you can reach through SoFi’s marketplace. Funding or funding timing is not guaranteed. Your experience with any lender will vary based on requirements of the lender and the loan you apply for. To determine the timing of funds availability, you must inquire directly with any lender. In addition, your access to any funds from a loan may be dependent on your bank’s ability to clear a transfer and make funds available.

†Credit score impact: To check the options, terms, and/or rates you may qualify for, SoFi and/or its network providers will conduct a soft credit pull that will not affect your credit score. However, if you choose a product and continue your application, the provider(s) you choose will request your full credit report from one or more consumer reporting agencies, which is considered a hard credit pull and may affect your credit. Rates may not be available from all providers.

©2025 SoFi Lending Corp. All rights reserved.

SOSMB-Q125-033

Business loans provide borrowers the capital they need to start a new venture, expand a business, or cover everyday operating expenses. In exchange for financing from a lending institution, businesses agree to repay the money borrowed over time, plus interest and fees.

There are many types of small business loans, each with eligibility requirements, costs, and repayment schedules. Here’s a guide to how business loans work.

What Is a Business Loan?

A small business loan is money loaned to a small business owner by a bank, credit union, or online lender. It must be repaid. The money can be used for any business-related expense that will aid the growth and continued operation of the business. Some owners need loans for everyday transactions, while others are looking for loans for business expansion.

Here are some examples of what a small business loan can be used for:

•   ​​Commercial real estate

•   Operation expenses

•   Debt consolidation

•   Equipment purchases

•   Equipment repairs

•   Refinancing

•   Inventory purchases

•   Startup costs

•   Research and development

•   Launching a new division or product line

•   Marketing and advertising

Types of Business Loans

There are various types of business loans, and it’s essential to understand how each works to choose the best option for your business. Here’s a look at some standard small business lending options.

Small business line of credit

A business line of credit is similar to a credit card. You can borrow up to a specific limit and only pay interest on the money you borrow. If you take out a small business line of credit, you can draw funds and repay them as often as you’d like if you don’t exceed your credit limit.

Accounts receivable financing

With accounts receivable financing, or invoice financing, you use your unpaid invoices as collateral to get a cash advance. Typically, invoice financing companies advance you a large portion of the value of your invoices. You receive the remaining percent (minus fees) when your invoices are paid. This can provide you with quick cash but can be costlier than other forms of financing.

Working capital loans

A working capital loan may be a good fit if you just need a small amount of cash to keep your business operating smoothly. However, keep in mind that repayment periods are short and interest rates can sometimes be higher than with other types of business loans.

Small business term loans

Term loans let you borrow a set amount of money that’s paid back with interest on a predetermined schedule. Both long-term and short-term small business loans are available. Which type will work best for you will depend on your business’s needs.

SBA small business loans

These term loans are offered through a lender insured by the SBA. Should the borrower default, the SBA will repay the lender most of the debt. Because SBA loans are government-backed, they come with lower interest rates and better terms for borrowers. However, they can be hard to qualify for.

Equipment loans

You might consider equipment financing if you want to purchase a new piece of equipment or machinery. With this type of small business loan, you typically get a quote for the equipment you’d like to buy, and a lender will front you a significant portion of the cost. The asset you purchase with the loan acts as collateral for the loan.

Small business credit cards

A business credit card is similar to a personal credit card, except it may provide reporting features to categorize and track your spending and a rewards program to help you save on typical business expenses. Some 0% APR credit cards offer no interest for a fixed period (often longer than a year).

Recommended: Business Term Loans: Everything You Need to Know

How to Find the Right Business Loan

There are many kinds of loans on the market. To find one that meets your needs and qualifications, even if yours is a business startup, here are some essential things to consider.

Requirements to qualify

Understanding a lender’s minimum requirements and qualifications can increase your chances of getting approved for a small business loan. While some lenders may be flexible, many require that borrowers meet a minimum credit score, annual revenue, and number of years in business.

Loans backed by the U.S. Small Business Association (SBA) tend to have the strictest requirements, while small business loans from direct online lenders and peer-to-peer lending sites are often less stringent.

Key terms to know

When you’re asking how do business loans work, it’s important to understand a few key business loan terms. Here are a few to become familiar with.

•   Repayment term: the amount of time a borrower has to repay the loan.

•   Fees/penalties: extra costs in addition to the interest you may need to pay, such as application fees, origination fees, and late fees.(The loan agreement usually lists all small business loan fees.)

•   Eligibility requirements: conditions the bank or lender requires the borrower to meet to qualify for financing.

•   Interest rates: what the lender charges for giving you access to the money, expressed as a percentage of the loan amount.

•   Principal: the total amount of money you borrow (not including interest).

•   Time to funding: how long it will take for the lender to distribute funds to the borrower

Types of Lenders That Offer Business Loans

Direct online lenders

You can apply directly with an online lender instead of working through a traditional bank. The benefit of doing this is that many online lenders have advanced technology to approve borrowers quickly and transfer funds. The drawback is that it’s not uncommon to get charged higher rates when working with a direct online lender than a traditional bank.

Large commercial banks

Large commercial banks are known for issuing loans with lower interest rates than their peers, but the drawback is that they tend to have strict qualification requirements that can be difficult to meet. Large commercial banks may be outside your reach if you’re a new business.

Large community banks

Community banks are locally owned and operated. Since they tend to be smaller than commercial banks, they can often provide you with more individualized service. These banks may also look at other aspects of your business besides your credit score.

Peer-to-peer lending sites

With peer-to-peer lending sites, any money you receive comes from a group of investors instead of a single lender or a bank. Peer-to-peer loans are often easier to qualify for but tend to cost more in the long run due to fees and higher interest rates.

SBA-backed banks

The Small Business Administration backs SBA loans. Since they present less risk to the lender, these loans tend to have lower interest rates and longer terms. However, they also typically have strict eligibility requirements.

How to Compare Lender Offers

All business loans are not created equal. Here are some things to consider when comparing business loans.

Interest rate need-to-knows

Some loans have fixed interest rates, while others have variable interest rates.

A fixed business loan has a set interest rate that remains unchanged over the loan’s life. Your loan payments will be the same each month until the loan is paid off.

An adjustable-rate business loan starts with a set interest rate that changes based on current market rates at a predetermined date. After that date, your monthly payments could be more or less.

Before choosing which one you want, research average small business loan interest rates.

Recommended: Fixed vs. Variable Rate Business Loan

Early payment penalties

Some lenders charge a prepayment penalty if you pay off your loan early, while others do not. A loan with higher interest rates but no prepayment penalties could be a better deal if you think there is a high chance you will pay the loan off early.

Late payment penalties

Find out what the fee is for making a late payment. How long do you have before you’re charged a late payment fee?

What does the lender consider a default?

It’s a good idea to determine what a lender considers a loan “default.” Sometimes, it only takes a slight cash flow change to potentially jeopardize your business. Of course, if you are ever in danger of defaulting, it’s always a good idea to speak with your lender early on, as they may be able to help.

Applying for a Business Loan

Once you find a loan you are interested in, the next step is filling out an application. When you apply for a small business loan, you typically need to provide the following paperwork:

•   I.D.

•   Bank statements

•   Proof of Ownership

•   Balance sheet

•   Personal tax returns

•   Business tax returns

•   Profit and loss statements

•   Voided business check

Once you have all your documents in order, how you’ll apply for the small business loan will depend on the lender. With online lenders, you can typically do everything (not surprisingly) online. However, more traditional financial institutions like banks and credit unions may require you to apply at a branch or over the phone.

Either way, double-check that your business loan application includes everything the lender requested in the appropriate format. This can help reduce any unnecessary back-and-forth so you can get a decision as quickly as possible.

Recommended: Best Cities to Start a Business in the U.S.

The Takeaway

Business loans are a form of credit offered by lenders to businesses. In exchange for this money, lenders require repayment of the principal with interest and fees added.

Usually, business loans require the borrower to make regular payments on a set schedule, but repayment terms and interest rates can vary depending on the lender and your business’s qualifications.

If you’re interested in finding out what type of loan you may qualify for, Lantern by SoFi can help. With our easy-to-use online tool, you can learn about an offer from a small business lender without obligation.

If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.

FAQ

How much income is needed for a business loan?

It depends on the lender and the amount of the loan. Lenders look at a company’s income (as well as its available cash) to ensure that the business will be able to repay the loan.

What are the rules for business loans?

The rules (or terms) will depend on the loan. Monthly payments, interest rates, and repayment periods all vary and will be listed and explained in your loan terms, but you should also be able to speak with your loan manager if you have any questions.

How do you pay back business loans?

Term loans typically require monthly payments. If a loan is very short-term, you may be required to make weekly payments. Most loan payments can be made online or over the phone.

How long are business loan terms?

Intermediate and long-term loans often have repayment periods between three and 10 years. If you take out an SBA loan, you may even have 25 years to pay off the loan.

Can you get a business loan with no down payment?

Yes, some loans allow you to put up collateral instead of making a down payment.

Photo credit: iStock/nortonrsx

SoFi's marketplace is owned and operated by SoFi Lending Corp.
Advertising Disclosures: The preliminary options presented on this site are from lenders and providers that pay SoFi compensation for marketing their products and services. This affects whether a product or service is presented on this site. SoFi does not include all products and services in the market. All rates, terms, and conditions vary by provider. See SoFi Lending Corp. licensing information below.

This content is provided for informational and educational purposes only and should not be construed as financial advice.

This article is not intended to be legal advice. Please consult an attorney for advice.

Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

External Websites: The information and analysis provided through hyperlinks to third-party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.
SoFi receives compensation in the event you obtain a loan, financial product, or service through SoFi’s marketplace. This webpage is owned and operated by SoFi Lending Corp., licensed by the Department of Financial Protection and Innovation under the California Financing Law, license number 6054612; NMLS number 1121636. ((www.nmlsconsumeraccess.org)). This page is NOT operated by SoFi Bank. Loans, financial products, and services may not be available in all states. All loan terms, including interest rate, and Annual Percentage Rate (APR), and monthly payments shown through SoFi’s marketplace are from providers and are estimates based upon the limited information you provided and are for informational purposes only. All rates, fees, and terms are presented without guarantee and are subject to change pursuant to each provider’s discretion. The actual loan terms you receive, including APR, will depend on the provider you select, their underwriting criteria, and your personal financial factors. The loan terms and rates presented are provided by the providers and not by SoFi Lending Corp. Please review each provider’s Terms and Conditions for additional details.

*Small Business Loans: Reference to “same day funding” or “funding within 24 hours” describes a general capability of many lenders you can reach through SoFi’s marketplace. Funding or funding timing is not guaranteed. Your experience with any lender will vary based on requirements of the lender and the loan you apply for. To determine the timing of funds availability, you must inquire directly with any lender. In addition, your access to any funds from a loan may be dependent on your bank’s ability to clear a transfer and make funds available.

†Credit score impact: To check the options, terms, and/or rates you may qualify for, SoFi and/or its network providers will conduct a soft credit pull that will not affect your credit score. However, if you choose a product and continue your application, the provider(s) you choose will request your full credit report from one or more consumer reporting agencies, which is considered a hard credit pull and may affect your credit. Rates may not be available from all providers.

©2025 SoFi Lending Corp. All rights reserved.

SOSMB-Q125-032

If you’ve ever had trouble getting approved for an affordable loan, a community development financial institution (CDFI) may be able to help.

These mission-based institutions focus on serving people in underserved communities that have historically faced obstacles to obtaining financial services. Instead of looking at traditional criteria (like credit scores and bank account history) to determine who qualifies for a financial product, they typically take a more flexible, holistic, and community-based approach.

Here’s a closer look at CDFIs, including how they work, what they offer, and how to find one in your area.

Purpose and Function of CDFIs

Community development financial institutions, or CDFIs, are specialized financial institutions that provide affordable financial services and investments to low-income individuals, BIPOC populations, and disadvantaged communities.

CDFIs must be certified by the U.S. Department of the Treasury’s CDFI Fund. Unlike traditional for-profit banks, CDFIs are typically non-profit or mission-based organizations formed to promote economic development, community revitalization, and financial inclusion. They include banks and credit unions, non-profit loan funds, and venture capital funds aiming to serve low-income communities.

CDFIs offer a range of financial services, including checking and savings accounts, low-cost mortgages for first-time homebuyers, and loans for small businesses. They also help community members develop financial literacy, establish saving goals, and build personal credit.

To find a CDFI in your area, you can use the Opportunity Finance Network’s CDFI locator, which is free to use and lists CDFI-accredited organizations. You can also contact local community development organizations, economic development agencies, or local banks to inquire about CDFIs operating in your area.

Recommended: 10 Small Business Grants for Minorites

Types of CDFIs

Several types of CDFIs cater to different financial needs within underserved communities. These include:

•   Community development banks. They focus on providing banking services to communities that mainstream financial institutions typically underserve. They offer a wide range of financial products, such as loans, savings, and checking accounts, tailored to meet the community’s needs.

•   Community development credit unions are member-owned financial cooperatives that offer banking services to their members. They are specifically designated as CDFIs and have a mission to serve underserved communities.

•   Community development loan funds. These are organizations that provide loans and other financial services to businesses and individuals in underserved areas. They often focus on lending to small businesses, affordable housing projects, and community development initiatives.

•   Community development venture capital funds. These funds invest in businesses and projects that have the potential to generate economic and social impact in underserved communities. They provide equity financing and strategic support to help these businesses grow and succeed.

Recommended: Mompreneurs: Real Life Struggles

How Is a CDFI Different From a Bank?

CDFIs differ from traditional banks in several ways. Here’s a look at some of the major differences.

Mission-oriented approach: CDFIs primarily aim to serve underserved communities and promote economic and social development. Their activities are driven by their commitment to community impact rather than maximizing profits.

Targeted services: CDFIs focus on providing financial services to individuals and businesses in low-income and underserved areas. They offer products and services specifically designed to meet the unique needs of these communities, such as small business loans, affordable housing financing, and financial education programs.

Flexible qualification criteria: CDFIs often have more flexible qualification standards than traditional banks. They typically consider factors beyond personal credit scores and collateral, considering the borrower’s character, community impact, and potential for positive change.

Localized interest and expertise: CDFIs are usually embedded within the communities they serve and are often involved in local boards and committees. This localized approach allows them to better understand and respond to the community’s unique needs and challenges.

Recommended: 10 Steps to Starting a New Business

What Are the Downsides of a CDFI?

While CDFIs can provide valuable resources to individuals and businesses in underserved and disadvantaged communities, there are some downsides associated with working with one that are worth being aware of.

•   Limited geographic coverage CDFIs are often focused on specific geographic areas or regions, so their services aren’t available everywhere.

•   Resource constraints CDFIs may face them due to their nonprofit or mission-based status. This can limit their capacity to scale operations, offer a comprehensive range of financial products, or compete with larger financial institutions regarding interest rates and fees.

•   Access to capital CDFIs rely on various funding sources, including grants, government programs, and private investments, which aren’t always reliable.

•   Limited technological advancements Due to resource constraints, some CDFIs may have limited access to advanced technology and digital banking capabilities. This can result in a less convenient and efficient banking experience than mainstream financial institutions.

Finding and Working With a CDFI

To find a CFGI, you can go to the Opportunity Finance Network and use its CDFI locator. Another option is to use the Treasury Department’s Searchable award database.

Filling out a Loan Application

If you want to pursue a loan from a CDFI, you will need the same things required for any small business loan application, such as personal and business tax returns, bank statements, income statements, and balance sheets.

Recommended: Guide to Requirements for Small Business Loan Applications

The Takeaway

CDFIs can be a great support system for individuals and businesses in low-income communities that have struggled to access traditional banking resources. These mission-focused institutions offer various financial services, including mortgages, small business loans, personal loans, auto loans, and bank accounts.

On the downside, CDFIs aren’t available in all communities and may not offer the most competitive interest rates. Annual percentage rates (APRs) on loans may be higher, while annual percentage yields (APYs) on savings accounts may be lower than what you could find at a for-profit financial institution.

If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.

FAQ

What is the role of CDFIs in promoting financial inclusion?

CDFIs help support and promote financial inclusion by providing accessible and affordable financial services to underserved communities. They focus on reaching individuals and businesses with limited access to traditional banking services due to low income, lack of credit history, or living in underserved areas. CDFIs offer a range of financial products and services tailored to meet the specific needs of these communities, including small business loans, consumer loans, bank accounts, and financial education programs.

How can I find a CDFI in my community?

To find a CDFI in your area, you can use the Opportunity Finance Network’s CDFI locator, which is free to use and lists CDFI-accredited organizations. This database allows you to search for CDFIs by state, city, or zip code.

In addition, you can contact local community development organizations, economic development agencies, or local banks to inquire about CDFIs operating in your area.

What types of financial services do CDFIs offer?

CDFIs offer a wide range of financial services tailored to the needs of underserved communities. These include: bank accounts and banking services, consumer loans, small business loans, affordable housing financing, financial education, and financial counseling.

How can I support CDFIs and their mission?

There are several ways you can support CDFIs and their mission. These include:

•   Becoming a customer of a CDFI

•   Spreading awareness of CDFIs

•   Investing or donating to a CDFI

•   Supporting policies and initiatives that promote the growth and sustainability of CDFIs

Photo credit: iStock/Drazen Zigic

SoFi's marketplace is owned and operated by SoFi Lending Corp.
Advertising Disclosures: The preliminary options presented on this site are from lenders and providers that pay SoFi compensation for marketing their products and services. This affects whether a product or service is presented on this site. SoFi does not include all products and services in the market. All rates, terms, and conditions vary by provider. See SoFi Lending Corp. licensing information below.

This content is provided for informational and educational purposes only and should not be construed as financial advice.

This article is not intended to be legal advice. Please consult an attorney for advice.

Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

External Websites: The information and analysis provided through hyperlinks to third-party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.
SoFi receives compensation in the event you obtain a loan, financial product, or service through SoFi’s marketplace. This webpage is owned and operated by SoFi Lending Corp., licensed by the Department of Financial Protection and Innovation under the California Financing Law, license number 6054612; NMLS number 1121636. ((www.nmlsconsumeraccess.org)). This page is NOT operated by SoFi Bank. Loans, financial products, and services may not be available in all states. All loan terms, including interest rate, and Annual Percentage Rate (APR), and monthly payments shown through SoFi’s marketplace are from providers and are estimates based upon the limited information you provided and are for informational purposes only. All rates, fees, and terms are presented without guarantee and are subject to change pursuant to each provider’s discretion. The actual loan terms you receive, including APR, will depend on the provider you select, their underwriting criteria, and your personal financial factors. The loan terms and rates presented are provided by the providers and not by SoFi Lending Corp. Please review each provider’s Terms and Conditions for additional details.

*Small Business Loans: Reference to “same day funding” or “funding within 24 hours” describes a general capability of many lenders you can reach through SoFi’s marketplace. Funding or funding timing is not guaranteed. Your experience with any lender will vary based on requirements of the lender and the loan you apply for. To determine the timing of funds availability, you must inquire directly with any lender. In addition, your access to any funds from a loan may be dependent on your bank’s ability to clear a transfer and make funds available.

†Credit score impact: To check the options, terms, and/or rates you may qualify for, SoFi and/or its network providers will conduct a soft credit pull that will not affect your credit score. However, if you choose a product and continue your application, the provider(s) you choose will request your full credit report from one or more consumer reporting agencies, which is considered a hard credit pull and may affect your credit. Rates may not be available from all providers.

©2025 SoFi Lending Corp. All rights reserved.

SOSMB-Q125-034

Net working capital is the difference between a company’s current assets and current liabilities. Positive net working capital indicates that a business can meet its short-term financial obligations and also invest in other activities and future growth. Negative working capital, on the other hand, suggests that a company may find it difficult to grow, pay back creditors, or even avoid bankruptcy.

Read on for a closer look at what net working capital is, how it’s calculated, and what it can tell you about your company’s financial position.

Recommended: Debt Factoring

What Is Net Working Capital?

Net working capital (NWC) is a measure of a company’s liquidity and short-term financial health.

NWC looks specifically at the difference between a company’s current assets (cash and assets that can be converted into cash within a year) and its current liabilities (payroll, accounts payable, taxes, and interest owed). It provides a window into how well a company has been managing its affairs, and how well it will be able to meet its short-term obligations, such as unpaid taxes and short-term debt.

Business owners will often calculate and track net working capital in order to monitor trends in liquidity from year to year, or quarter to quarter. Analyzing these trends can help owners make accurate financial projections. That accuracy is important for making informed decisions, pitching investors, and pursuing loans.

Lenders are likely to consider net working capital when a company is applying for a small business loan to determine if the firm is financially strong enough to take on the debt payments.

Net Working Capital Formula

The basic formula for how to calculate net working capital is straightforward:

Current Assets – Current Liabilities = Net Working Capital

What Is Included in Net Working Capital?

Current Assets

A current asset is anything on a company’s balance sheet that can be converted to cash in less than a year. This can include:

•   Accounts receivable

•   Cash (or a cash equivalent)

•   Commercial paper

•   Inventory

•   Marketable securities (e.g., U.S. Treasury bills, money market funds)

•   Short-term investments a company intends to sell within one year

•   Treasury bills

•   Short-term notes receivable (e.g., short-term loans to customers or suppliers)

•   Prepaid expenses, such as insurance premiums

•   Advance payments on future purchases

For example, if company ABC has $100k in cash, $15k in accounts receivable, and $10k in inventory, then that company would have $125k in current assets.

Current Liabilities

A current liability is any financial obligation a company owes that is due within one year. This includes:

•   Accounts payable

•   Interest payable on loans

•   Any loan principal that must be paid within a year

•   Deferred revenue (e.g., advance payments from customers)

•   Rent

•   Taxes payable

•   Utilities

•   Trade credits

•   Vendor notes

•   Wages

•   Other accrued expenses payable

For example, if company ABC has $15k in accounts payable, $2k in accrued liabilities, and $10k due on a working capital loan this year, then that company would have $27k in current liabilities.

Company ABC’s net working capital would be current assets ($125k) minus current liabilities ($27k), or $98k.

Recommended: Working Capital Assessment

Strategic Significance

Having ample working capital increases a business’s strategic options. Smart management of working capital — using multi-step income statements and other tools — enables a company to jump on unexpected opportunities without financing delays. Greater liquidity also strengthens a business’s negotiating position with suppliers or creditors.

How Does Net Working Capital Work?

A company’s working capital is used to fund operations and meet short-term financial obligations. If a company has sufficient working capital, it will be able to pay its employees and suppliers, pay interest on any loans, pay taxes, and pay other short-term financial obligations, even if it runs into cash flow challenges.

Having positive working capital can also mean that a business can fund growth without incurring debt. Or, if they decide to apply for financing, that positive working capital can make it easier for them to qualify for a small business loan or other form of credit with attractive rates and terms.

How much working capital a company needs will depend on its size and industry. Generally, industries with longer production cycles require more working capital, since turnover of inventory is slower. Companies that make sales daily (like large retailers), on the other hand, can generate funds quickly and tend to need less working capital. When you’re analyzing your company’s net working capital management, a budgeted income statement is a good place to start.

Calculating Net Working Capital

While the net working capital formula is simple, you may be unsure about how to account for all of your company’s current assets and liabilities.

Fortunately, all the components of working capital can be found in a company’s balance sheet, which is a snapshot of the company’s assets, liabilities, and shareholders’ equity at a moment in time (usually at the end of a quarter or fiscal year).

Assets are listed by category in order of liquidity (the ease with which they can be converted into cash), starting with cash and cash equivalents, followed by long-term assets (which cannot be liquidated within the next year).

Liabilities are listed in the same way, starting with current liabilities (due within one year), followed by long-term liabilities (due at any point after one year).

Uses of Net Working Capital

Net working capital is ultimately a tool that can be used by analysts, business owners, and lenders to determine how well a company is performing. While it doesn’t provide a complete picture, net working capital is a valuable variable in understanding how solvent a company is, and whether or not that company can take on additional debt.

If net working capital is positive, for example, it indicates that the business has short-term funds available from its current assets that are more than sufficient to pay for its current liabilities as they come due for payment.

If, on the other hand, NWC is negative, the business may not have sufficient funds available to pay for its current liabilities, and could, in fact, be at risk for bankruptcy.

Net Working Capital vs Working Capital

If you know what working capital is, then you know what net working capital is. The two are generally considered one and the same. Both refer to the difference between all current assets and all current liabilities.

However, some analysts will define net working capital more narrowly than working capital. They might instead use this formula:

NWC = Current Assets (Less Cash) – Current Liabilities (Less Debt)

Key Differences

When derived from the narrower equation shown above, net working capital excludes cash from current assets. For most businesses, cash is not part of operations, so some experts feel that disregarding cash gives a truer picture of operations.

Also, by excluding debt from the calculation, this equation offers a more detailed view of liquidity: It reveals the excess or shortfall of non-cash assets.

Pros and Cons of Using Net Working Capital

Example of Net Working Capital Calculations

Company XYZ has the following in current assets and current liabilities.

Current Assets:
Cash: $40,000
Inventory: $15,000
Accounts receivable: $10,000
Total: $65,000

Current Liabilities:
Short term debts: $15,000
Accounts payable: $10,000
Accrued liabilities: $5,000
Total: $30,000

Net Working Capital:
Current Assets ($65,000) – Current Liabilities ($30,000) = NWC ($35,000)
NWC = $35,000

Net Working Capital Schedules

A net working capital schedule is a statement of change in the net working capital of a company. It is often created by an analyst using an Excel spreadsheet, and is calculated in accordance with GAAP (generally accepted accounting principles), using the accrual method of accounting.

Accrual accounting is when expenses and sales are recorded at the time of the transaction and not necessarily when the money is received or spent.

A net working capital schedule includes sales and cost of goods sold from the income statement for all relevant periods. It also separates current assets and current liabilities into two sections, and creates a final total for net working capital. It may also create another line to calculate the increase or decrease of net working capital in the current period from the previous period.

The schedule will typically also include historical data, as well as forecast data, so it can be used to track changes in NWC and forecast future NWC.

Changes in Net Working Capital

Changes in working capital indicate whether a company’s short-term assets are increasing or decreasing in relation to its short-term liabilities. To measure the change, you can use the following formula:

Change in NWC = Beginning NWC – End NWC

It’s generally more useful to compare multiple quarters than it is to compare only the most recent two. This allows you to identify trends. For example, a new business loan will increase a company’s current liabilities, but if it’s “good” debt, the company will be able to use it to its advantage to increase profits. However, it may take more than one or two quarters to see whether the debt was a good decision or not.

Changes in revenue are also to be expected. It can take multiple changes in working capital to determine whether a business is truly on the up and up or going through a downward trajectory.

Performance Indicators

Performance metrics, including data from balance sheets and financial statements, affect your net working capital calculations. For example, an upswing in accounts receivable (current assets) could cause your working capital figure to go up. Knowing you have more working capital, you and your company could reinvest in operations improvements to reach additional performance goals.

Net Working Capital Ratio

The net working capital ratio compares a company’s current assets to its short-term liabilities. Like NWC, the NWC ratio can be used to determine whether a firm has sufficient current assets to cover its current liabilities. If not, your business may need to take out a working capital line of credit.

To calculate your company’s working capital ratio, you simply divide your current assets by your current liabilities:

Current Assets ÷ Current Liabilities = Net Working Capital Ratio

Example:
A company has $75k in cash, $100k in inventory, and $200k in accounts receivable. It has $200k in accounts payable and $100k due this year on a business loan. Therefore:

$375k ÷ $300k = 1.25

A working capital ratio of less than 1.0 can suggest potential future liquidity problems. An ideal ratio is generally somewhere between 1.5 and 2.

The Takeaway

Net working capital is the difference between a company’s current assets and its current liabilities. Positive working capital indicates that a company can pay its bills and invest to spur business growth.

As a small business owner, it’s a good idea to calculate and manage your net working capital. This helps ensure that your company can meet its day-to-day operating expenses while using its financial resources in the most productive and efficient way. Lenders generally like to see positive NWC because it suggests that a company can take on additional debt and keep up with payments.

If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.

FAQ

How is net working capital calculated?

To calculate net working capital, you subtract a company’s current liabilities from its current assets:

Net Working Capital = Current Assets – Current Liabilities

What is net working capital on a balance sheet?

Net working capital is calculated using items from a balance sheet (including cash, accounts receivable, inventory, accounts payable, interest payable on loans, and taxes payable). However, it is not an item featured on a balance sheet.

How are working capital and net working capital different?

Net working capital and working capital are typically synonymous. Both refer to the difference between a company’s current assets and current liabilities.

Some analysts, however, define net working capital in a more narrow way than working capital, and will exclude cash from current assets and debt from current liabilities.

What does a positive net working capital indicate?

Positive net working capital shows that the business’s current assets contain enough short-term funds to cover its current liabilities as they come due for payment.

How can businesses improve their net working capital?

To improve its net working capital, a business can increase its current assets, reduce its current liabilities, or both. For example, securing extra inventory might boost a company’s assets; refinancing your business debt at a lower rate could help bring down liabilities.

Photo credit: iStock/insta_photos

SoFi's marketplace is owned and operated by SoFi Lending Corp.
Advertising Disclosures: The preliminary options presented on this site are from lenders and providers that pay SoFi compensation for marketing their products and services. This affects whether a product or service is presented on this site. SoFi does not include all products and services in the market. All rates, terms, and conditions vary by provider. See SoFi Lending Corp. licensing information below.

This content is provided for informational and educational purposes only and should not be construed as financial advice.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

SOSMB-Q225-008

Wondering whether a sole proprietorship or corporation is a better business structure for your company? These business types differ sharply when it comes to formation, taxation, and personal liability. When choosing between them, there’s no right or wrong answer; your selection should depend on your business model and goals.

Understanding Sole Proprietorships

When you’re researching whether to form a sole proprietorship versus corporation, you’ll find that the sole proprietorship model is easier to set up and operate. There is no formal paperwork needed besides licenses or permits based on your business type and local laws. That may be why it’s the most common business structure in the U.S.

A sole proprietorship is a popular option for consultants, freelancers, home care assistants, professional cleaners, and landscapers — or any other business with just one person providing the product or service.

A sole proprietor owns and runs an unincorporated business alone. Any business income passes through to you as personal income, meaning you need to file only your 1040 tax return plus a Schedule C form.

Advantages and Disadvantages

As you can imagine, there are both pros and cons to sole proprietorship. Here are some examples:

Pros

•  Sole ownership: A sole proprietor has complete ownership of the company, with full control of all business and financial decisions.

•  Streamlined taxation: With a sole proprietorship, business income is considered personal income, so you only have to file one tax return.

•  Easy setup: Forming a sole proprietorship requires minimal paperwork; you achieve this status automatically just by conducting business activities.

Cons

•  Personal liability: As a sole proprietor, you’re personally liable for business-related debts and other responsibilities. That puts your personal assets at risk in case of loan defaults or lawsuits.

•  Financing challenges: If you want to grow your business with external funding, you may have a harder time with a sole proprietorship. For example, you can’t raise funds by selling company stock. Also, according to the Small Business Administration (SBA), many banks won’t lend money to sole proprietorships. That may be the case even for secured loans like equipment loans.

•  No tax benefits: When looking into the tax benefits of a sole proprietorship vs. corporation, you may find that a corporate structure allows you to take more deductions.

Taxation for Sole Proprietorships

Sole proprietorships do have tax issues to consider. A sole proprietorship is a “pass-through” entity. This means all of the business proceeds pass through the company to the owner as personal income, which must be reported on your personal tax return.

Sole proprietors earning more than $400 must also pay self-employment tax, which takes the place of Social Security and Medicare contributions that an employer would typically cover. The self-employment tax rate is 15.3%. For earnings above $168,600 (in 2024), the tax is reduced, depending on your income.

The final tax consideration for sole proprietorships is the need to pay quarterly estimated taxes. This is typically required if you expect to owe more than $1,000 for the tax year. Underpaying your estimated tax through the year can result in a penalty.

Recommended: Sole Proprietorship vs. LLC: How to Choose

Understanding Corporations

Forming a corporation creates a separate legal entity that shields your individual finances. Incorporating your business takes more upfront work, but there are some advantages, especially if you plan to apply for small business loans to grow your company over time. Here’s an overview of the different types of corporations you can choose from.

Types of Corporations (C, S, and B)

You can choose from three types of corporations. Each has slightly different features to consider.

•  C corp: This is a basic corporation, a separate legal entity from its owner or owners. You must file articles of incorporation in the state where the company does business. You’ll need to have a registered agent, a set of bylaws, and regular board meetings.

•  S corp: An S corp is a type of corporation that involves some extra legwork but yields certain benefits. Like a C corp, it shields the business owner from personal liability. Like a sole proprietorship, it avoids double taxation; profits and losses are passed through to the owners without being subject to corporate taxes. This is similar to an LLC’s tax benefits. But the IRS’s rules for S corp status do limit the company’s number of shareholders and stock classes.

•  B corp: A B corp is a benefits corporation that balances its financial profits with the mission of providing some kind of public benefit. The business’s taxation profile is that of a C corp. However, this status is not available in all states.

Advantages and Disadvantages

Here’s what to consider when weighing the pros and cons of a corporation over a sole proprietorship.

Pros

•  No personal liability: A corporation is its own separate legal entity; this keeps the owners’ personal assets safe from any kind of liability related to the business.

•  Easier business financing: You can sell company stock to investors and improve your odds of corporate financing through a loan or business line of credit.

•  Company longevity: A corporation can continue to exist after your departure or death, unlike a sole proprietorship.

Cons

•  Formation is more expensive: States typically charge higher fees for registering a corporation than for other types of business entities.

•  Recordkeeping requirements: Recordkeeping rules vary by state, but often you must submit annual reports and maintain records of shareholder and director meetings.

•  Taxation varies: Income from C corps and B corps generally faces double taxation, once at the corporate level and once on owners’ personal tax returns. Setting up your business as an S corp frees you from paying corporate tax on your earnings.

Taxation for Corporations

A corporation must file its own tax return, separate from the individual owners, using IRS Form 1120. This brings together the business financials — including income, credits, and deductions — to determine the company’s tax bill. The flat tax rate for corporations is 21%.

Employment taxes are also required. You’ll file quarterly forms recording the income, Social Security, and Medicare taxes you’re paying on behalf of your employees.

Finally, business owners may owe income tax on any earnings or distributions taken from the company. Calculating the tax depends on whether you’ve elected S corp status through the IRS.

Recommended: Startup business loans

Side-by-Side Comparison

See the pluses and minuses of a sole proprietorship versus corporation, based on both short-term and long-term business considerations.

Formation, Liability, Taxes, and Growth Potential

Choosing the Right Structure for Your Business

Choosing between a proprietorship vs. corporation depends on factors like how risky your business is and how you plan to grow in the future.

When to Choose Each Option

A sole proprietorship is better for lower-risk companies. If the chance of a lawsuit is minimal — such as with a tutoring service or drop-shipping business — it’s less likely that your personal assets will be at risk. Additionally, as the only owner of a sole proprietorship, you can make all the decisions.

Setting up a corporation may be wiser if you want support from multiple owners. If lawsuits are a possibility, this status will protect your personal assets by keeping them separate from the business. Incorporating your business may also be a better choice if you foresee raising capital through investors or getting financing from a lender in the future.

💡 Recommended: Types of Businesses Explained

The Takeaway

Deciding what governance structure to adopt is a strategic business move. When making the choice, consider your long-term plan for your business. If you expect to need investor capital, lender financing, and employees, incorporating may be the way to go. If you expect to keep running a solo shop and prefer straightforward tax rules, a sole proprietorship may be right for you.

If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.

FAQ

What are the main differences between a sole proprietorship and a corporation?

There are several differences when choosing between a sole proprietorship or corporation. A sole proprietorship is easier to set up but doesn’t protect you from personal liability. A corporation does separate business and personal liability, but is more complicated to set up and forces compliance with recordkeeping rules.

Which business structure offers better liability protection?

A corporation offers better liability protection because the individual and the business are two separate legal entities. In case of liability or bankruptcy, only the assets of the business are paid out or sold. The assets of the corporate shareholders are protected. This is not the case with a sole proprietorship.

How do taxes differ between a sole proprietorship and a corporation?

With a sole proprietorship, all business income flows through to the owner and is treated as personal income. By contrast, a C corporation must pay taxes on its income before being paid out to the shareholders.

Is it easier to start a sole proprietorship or a corporation?

A sole proprietorship is easier to start because there is minimal paperwork required.

Can a sole proprietorship be converted into a corporation?

Yes, you can convert a sole proprietorship to a corporation by forming a new entity and transferring any business assets to the new corporation.

Photo credit: iStock/Caiaimage/Paul Bradbury

SoFi's marketplace is owned and operated by SoFi Lending Corp.
Advertising Disclosures: The preliminary options presented on this site are from lenders and providers that pay SoFi compensation for marketing their products and services. This affects whether a product or service is presented on this site. SoFi does not include all products and services in the market. All rates, terms, and conditions vary by provider. See SoFi Lending Corp. licensing information below.

This content is provided for informational and educational purposes only and should not be construed as financial advice.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

SOSMB-Q125-031