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Working capital for small businesses powers daily operations and fuels growth. It’s the amount of liquid cash a small business has available for expenses like operational costs, payroll, and inventory. By definition, working capital is the difference between a business’s assets and debts (or accounts payable).

When a business has enough cash to cover its operating expenses and invest in future growth, it has positive working capital. When it doesn’t have enough, it has negative working capital.

If a business has negative working capital, it may want to seek out a working capital loan. There are numerous types of small business working capital loans available, including term loans, lines of credit, and invoice financing. Let’s walk through some options that may be a fit for your small business.

What Is a Working Capital Loan?

A working capital loan is a type of small business funding that can work well for a small business with negative working capital or fluctuating cash flow. This type of loan offers short-term financing to cover expenses like:

•  Monthly bills

•  Debt payments

•  Payroll

•  Inventory

•  Operational expenses

•  Emergency expenses

Unlike commercial real estate loans or large business loans, working capital loans aren’t intended for long-term investments or big purchases.

Since working capital loans are typically smaller loans, many types of lenders offer this type of business financing. Banks, credit unions, online lenders, peer-to-peer (P2P) lenders, and alternative lenders are all potential sources for working capital loans. Each has varying eligibility requirements and business loan terms, so it’s a good idea to do some research to determine which option suits your needs best.

What Can a Working Capital Loan Be Used For?

Many small businesses don’t have predictable cash flow or sufficient assets, resulting in negative working capital. Seasonality, sales cycles, holidays, or economic fluctuations can all contribute to negative working capital. It is common for startups, restaurants, manufacturers, or less-established small businesses to have negative working capital. Without reliable revenue, these businesses may turn to working capital loans.

Depending on your business needs, you can use working capital loans to:

•  Manage cash flow: Working capital loans can help maintain smooth operations during periods of uneven cash flow, ensuring bills and expenses are paid on time.

•  Manage seasonal business expenses: Businesses with seasonal fluctuations can use these loans to cover costs during off-peak periods.

•  Cover emergency expenses: In the event of unexpected expenses, a working capital loan provides quick access to funds.

•  Grow your business: These loans can also be used for short-term investments, such as marketing campaigns or purchasing additional inventory, to support business growth.

How to Calculate Working Capital

To calculate your business’s working capital, start by identifying your current assets and current liabilities.

Current assets are things that currently belong to your business and could easily be converted to cash within one year or one business cycle (whichever is shorter). These can include:

•  Cash (checking and savings accounts)

•  Accounts receivable

•  Inventory

•  Assets soon to be paid off or liquidated

•  Stocks, bonds, and mutual funds

Current liabilities are expenses that must be paid within the next year or business cycle. These can include:

•  Rent

•  Utilities

•  Supplies

•  Principal and interest payments on any debt

•  Accounts payable

•  Accrued taxes

•  Long-term debt that will be due in the short-term

After adding up your current assets and liabilities, calculate working capital using the following formula:

CURRENT ASSETS – CURRENT LIABILITIES = WORKING CAPITAL

For example, if your business has $200,000 in current assets (property, cash, inventory, etc.) and $75,000 in current liabilities (rent, debt payments, taxes, payroll), your positive working capital is $125,000.

$200,000 – $75,000 = $125,000

Conversely, if your business has $100,000 in current assets but $150,000 in current liabilities, you would have $50,000 in negative working capital.

$100,000 – $150,000 = -$50,000

Positive working capital is a sign of good business health. It’s usually an indicator that you’re in a good place to expand. Negative working capital can indicate financial troubles, which could ultimately lead to defaulting on debt payments or entering bankruptcy. For this reason, determining your working capital is an important step in planning for your business’s growth.

Types of Working Capital Loans

Working capital loans can help if your business needs extra cash. Several loan products offer short-term solutions. Keep in mind that not all will be suitable for every business, so be sure you understand each loan option before making a decision.

SBA 7(a) and 7(a) Express Loans

SBA loans are offered through approved Small Business Administration (SBA) lenders and provide flexibility for various working capital expenses. The SBA Express program offers a faster review time of around 36 hours, with a maximum loan amount of $500,000. The standard SBA 7(a) loan can provide up to $5 million but may take longer to process.

SBA-backed loans offer low interest rates and are suitable for short- and long-term expenses. Loans of $25,000 or less do not require collateral. However, eligibility requirements vary, and qualifying can be challenging. Good credit, proof of revenue, and a business plan are essential for application.

Short-Term Loans

Short-term business loans are used to secure working capital, providing a sum of money up front that is typically repaid with interest over 18 months or less. These loans are ideal for businesses needing quick cash that can repay the loan in a short time frame.

They are often easier to obtain for borrowers with poor credit or less-established businesses, as they pose less risk to lenders. However, short-term loans typically have higher interest rates and lower borrowing amounts than other term loan products.

Lines of Credit

A business line of credit is a small business working capital loan that can help manage cash flow and cover small expenses. Like a credit card, it provides a set credit limit to borrow from, with interest charged only on the money withdrawn. These lines of credit are often revolving but can also end when the balance is paid off.

This option is useful for businesses with seasonal fluctuations, sales cycles, or emergency expenses. It’s typically easier to qualify for business lines of credit because the funding amounts are smaller and the debt is short term. However, consider the additional fees and lower borrowing limits before opening a business line of credit.

Invoice Factoring

Invoice factoring is when a business sells its unpaid invoices to a factoring company at a discount in exchange for immediate cash to cover working capital expenses. The factoring company then owns the invoices and collects payments directly from the business’s customers.

This option can be ideal for businesses with irregular billing cycles, allowing them to cover operating expenses without waiting for customer payments. The factoring company provides a percentage of the invoice value up front, which can be used to reinvest in the business or pay expenses.

Costs can be high due to fees and high APRs, and the business loses control over collections, so choosing a reputable factoring company is essential.

Inventory Financing

Inventory financing is a short-term working capital loan that provides funds to purchase inventory, using the inventory itself as collateral.

This financing is helpful for retailers managing cash flow fluctuations due to seasonality or revolving inventory, allowing them to pay for products up front in anticipation of high sales periods. The amount of financing and interest rates can vary, and since inventory depreciates over time, the loan amount may not reflect the inventory’s original purchase price.

Merchant Cash Advances

A merchant cash advance offers businesses cash upfront in exchange for a percentage of future credit card sales, with automatic withdrawals made daily or weekly from the borrower’s bank account.

Merchant cash advances are helpful for businesses needing quick access to cash, especially those with bad credit or newly established operations without other loan options. They can be expensive due to higher costs associated with the increased risk to the lender, meaning borrowers pay more for the convenience of fast cash.

Bank Overdraft Facility

A bank overdraft facility provides a business with access to cash even if its account is empty or overdrawn. The bank continues processing payments for a set period so the business can meet its financial obligations.

This option is useful for small businesses with inconsistent cash flow or negative working capital. It acts as a backup plan until additional funds are available. Keep in mind that interest is charged on the loan, and there may be additional fees when an overdraft occurs.

Pros and Cons of Working Capital Loans

Working capital loans can be a valuable resource for small businesses needing immediate funds to cover operational expenses. Like any type of business loan, they have their own set of advantages and disadvantages.

The pros of working capital loans may include:

•  May not require collateral (unsecured loans)

•  Can help improve cash flow

•  Let you maintain ownership of your business

•  May involve a faster loan process than other products

•  Come in numerous types of loan products

A few potential cons may include:

•  Certain loans may require a higher credit rating

•  Interest rates may be high on certain loan products

•  May affect both your personal and business credit

Recommended: Business Expansion Loans

How to Get a Working Capital Loan

The process for getting a working capital loan for your small business will depend on the type of loan product and the lender. Generally, the following steps will help you find, apply for, and obtain a loan for your small business.

•  Determine the loan purpose and amount: Consider how much money you need, how often you’ll be able to make payments, your budget for making payments, and whether you have any other sources of funding.

•  Choose a loan type: Research the different types of loans available and choose the best fit for your business needs.

•  Assess your qualifications: Check that your qualifications match the loan product you want to apply for. Some things to consider are personal/business credit ratings, collateral, and your working capital.

•  Choose a lender: Compare small business lenders that align with your needs and qualifications (and their associated terms, conditions, and fees) before choosing the best fit.

•  Submit your application: Prepare necessary documentation, such as financial records, business plans, and cash flow projections. Then, submit your application to the lender.

•  Partner with your lender: After you’ve submitted your application, continue working with your lender to ensure that the process goes smoothly and you can receive funds promptly.

Recommended: How to Read Financial Statements: The Basics

Alternatives to Working Capital Loans

If you’re looking for additional financing for working capital or have long-term financing needs, the following types of loans may be helpful:

•  Restaurant loans: Offered by several types of lenders, restaurant loans help with costs when you’re starting or expanding a restaurant business.

•  Franchise financing: A franchise loan can help with the expenses of opening a franchise. There are franchise companies that specialize in offering loans specifically for franchise owners.

•  Equipment financing: Equipment loans are useful for purchasing business equipment. The loan term is typically equal to the equipment’s expected lifespan, and the equipment acts as collateral for the loan.

•  Personal loans: If you don’t qualify for working capital loans, you may want to consider a personal business loan. This type of loan can give you more flexibility than a business loan.

•  Trade financing: Trade financing helps international businesses manage working capital by transferring payment or goods risks to third parties through options like bank guarantees and letters of credit.

•  Customer advances: Consider charging customers in advance instead of at delivery to receive cash up front, which frees up working capital.

•  Vendor credit: If you regularly purchase from the same vendors, ask if you can open a credit account. This allows you to pay your invoices in 30, 60, or 90 days.

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 a working capital loan?

A working capital loan is a type of business loan used to help pay for everyday operations and expenses. Types of working capital loans include short-term business loans, business lines of credit, merchant cash advances, and invoice financing.

How do you qualify for a working capital loan?

To qualify for a working capital loan, a lender assesses your credit, revenue, and business history. While there are working capital loans for startups and those with poor credit, the best loans and rates will be reserved for those with solid credit scores, a business history of at least one year, and positive revenues.

What is an example of a working capital loan?

An example of a working capital loan is a short-term business loan. These loans are typically 18 months or less and are given to the borrower in one lump sum. Payments are made monthly, and the interest rate is determined by the market and the business’s financial profile, including credit score and annual revenue.

About the author

Julia Califano

Julia Califano is an award-winning journalist who covers banking, small business, personal loans, student loans, and other money issues for SoFi. She has over 20 years of experience writing about personal finance and lifestyle topics. Read full bio.

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.

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.

SOSMB-Q324-026

An employer of record (EOR) is an outsourced service that oversees a business’s employee and human resources administration. Hiring an EOR shifts the legal responsibility for many personnel actions from the core business to the third-party provider. There are many reasons a company might engage an employer of record, including expansion into international locations with different laws and regulations.

Understanding Employer of Record Services

By hiring an EOR service, a business can focus on its main operations without having to learn employment laws, particularly those in jurisdictions far from the company’s home base. The business itself continues to manage its employees and day-to-day operations, but employment-related compliance is in the hands of the employer of record.

Delegating personnel and payroll tasks to an EOR might well save time and effort for entrepreneurs starting a small business.

Definition and Core Functions

So what is EOR for your business? Employer of record services can handle almost all of the administrative aspects of hiring, firing, and paying employees. Companies may choose to outsource various HR-related tasks and responsibilities, including:

•  Employee onboarding

•  Payroll (domestic and international)

•  Employment taxes

•  Benefits and compensation administration

•  Employee terminations

•  Workers’ compensation

•  Unemployment

•  Regulatory compliance with local and national employment laws

Every company’s needs will be different, of course, especially if overseas employees or contractors are involved. EOR services typically handle employee or contractor onboarding, but not recruitment or candidate vetting.

EOR vs PEO vs Staffing Agency

EORs are just one type of personnel-related service agency. Growing companies may want to engage different types of employment-related services, depending on their needs. Three common types are EOR firms, professional employer organizations (PEO), and staffing agencies. Any of these could be a prudent way to spend some of your startup business loans if warranted.

It’s important to understand how they differ in order to hire an agency that can deliver what you need. Here’s a breakdown of their various responsibilities.

•  Employer on record (EOR): An EOR is the legal employer of the workers at your company. It is responsible for keeping your business in compliance with all of the relevant labor laws. It is most useful for companies that have a multinational workforce.

•  Professional employer organization (PEO): A PEO offers administrative services similar to an employer of record, but the legal responsibility is different. When your company partners with a PEO, your business remains the legal employer of your staff. The PEO is considered a co-employer, and both parties share legal responsibility for abiding by employment law.

•  Staffing agency: A staffing agency offers completely different services from an EOR or PEO, focusing on recruitment rather than employee administration. The staffing agency helps with tasks like creating job listings, sourcing candidates, and even negotiating contracts. But once your company hires the new employee, the staffing agency’s work with that person is done.

How an Employer of Record Works

As a business grows, whether through profit reinvestment or loans for business expansion, an employer of record can provide support in many ways.

Legal and Administrative Responsibilities

An employer of record is responsible for all of the legal and compliance duties that go with employing workers across multiple jurisdictions. In addition to administering many HR processes, an EOR also oversees complex legal matters, including:

•  Labor law requirements

•  Tax regulations

•  Mediation

•  Workplace safety

This means that the client company can manage the employees’ work without having to spend its own resources tracking states’ or countries’ regulations and reporting requirements.

Global Employment Considerations

Businesses commonly engage an employer of record to help manage some sort of international expansion. Perhaps your business plan involves entering a new global market. Or maybe your company has decided to hire a remote team in another country.

While such moves can be beneficial for business growth, they add the burden of having to manage multiple unique labor laws and tax rules. An employer of record service can handle areas of risk mitigation and compliance that may be entirely new to you. You can turn your attention instead to finding the small business loans your company needs for expansion.

Another plus: You can stay onboard as the legal employer of your U.S. staff and use an EOR solely for international employees.

Benefits of Using an Employer of Record

Hiring an employer of record can give you several advantages.

Risk Mitigation and Compliance

One of the biggest benefits of an EOR is risk mitigation. The EOR, not your company, will be responsible for understanding and implementing local labor laws. An EOR reduces your risk of misclassifying independent contractors and employees; it can ensure that correct payments are made for taxes and benefits.

An EOR is also designed to stay on top of regulatory changes to make sure your company stays in compliance with the latest requirements. Also, many countries have different termination requirements. In the U.S., for example, termination laws are more relaxed and employees can be let go “at will.” But in other countries, employment law may require a notice period of several months depending on tenure.

Cost and Time Savings

In addition to lowering your business’s risk, using an employer of record can save both time and money. For starters, it can gain you entry into a new country or other jurisdiction much faster than if you decided to take on that responsibility internally.

An EOR service already has its own legal entity established, which gets things moving more quickly and saves your business upfront registration and administrative fees. Plus, managing compliance risk means there’s less chance you’ll be unexpectedly fined.

Recommended: Equipment loans

When to Consider Using an EOR

There are several scenarios in which it could make sense to use an employer of record:

•  Expanding hiring into a new region to test a new market

•  Growing a remote team internationally by seeking out top talent overseas

•  Changing workers’ status from independent contractor to employee

Expansion Scenarios and Use Cases

Here are a few examples of how an employer of record could assist a business’s move into new jurisdictions.

•  Filling skills gaps: Companies needing specialists can turn to an EOR to hire workers with niche skills in one or many locations.

•  Enabling temporary work: Rather than opening an entire regional office in a new location for what may be a limited time, your company can hire an EOR to have a presence in that place. Your business can operate on its own timeline, without the burden of having to create a permanent legal entity.

•  Easing international acquisitions: Quickly onboard staff from a newly acquired overseas company while complying with all relevant labor laws.

•  Minimizing financial commitment: Using an EOR is a way to get established in a new region without making a sizable investment or tapping into a business line of credit. It gives you time to evaluate the success of the new venture before you decide to make it permanent. Your company will have the option to take over employment contracts in the future if desired.

Recommended: 15 Types of Business Loans to Consider

The Takeaway

Using employer of record services comes with major advantages. An EOR can help speed up the process of hiring people in another country. The EOR also assumes employment risk in any new jurisdictions, which can save time and money. EOR services include payroll, tax, and benefits administration, all in compliance with the local regulations.

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 an EOR and a PEO?

What an employer of record does is not quite the same as what a professional employer organization does. An EOR acts as the sole legal employer in a specified jurisdiction, while a PEO is officially a co-employer of your staff. Both offer similar administrative services, but an EOR bears more legal responsibility.

How much does an Employer of Record service typically cost?

The cost of an EOR varies depending on location and the breadth of services you require. Typically, a business will pay a one-time setup fee (which may be higher in more complicated jurisdictions) as well as an ongoing monthly fee. The monthly charge for baseline EOR services can range from $199 to $650 per employee — or more.

Can an EOR help with international hiring compliance?

Yes, one of the main functions of an EOR is to help companies stay in compliance with international employment and tax laws.

Do employees know they’re hired through an EOR?

Yes, employees will know they’ve been hired through an EOR because the EOR is their legal employer. Even so, they’ll expect to work directly with your company on daily tasks and responsibilities.

How does using an EOR affect company culture and employee experience?

Using an EOR can be beneficial for employees because it ensures their benefits and compensation are handled fairly and legally. An EOR can also standardize processes so that the experience of employees around the globe remains consistent.

Photo credit: iStock/nimis69

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-Q125-029

The U.S. has more than 33.2 million small businesses, accounting for 99.9% of all businesses in the country. A huge driver of this business-friendly environment is the U.S. Small Business Administration, or SBA for short. The SBA encompasses various programs, from free education to affordable financing and disaster relief.

What Is the Small Business Administration?

The Small Business Administration (SBA) is a federal agency designed to support and promote small businesses in the U.S., largely by making guaranteed SBA loans. There are local district offices across the country that offer development and training for growing businesses.

Recommended: Conventional business loans vs. SBA loans

History and Mission

The SBA’s definition was formed in 1953 and is strongly rooted in the mission the agency created then. It began making guaranteed business loans from its early days, along with focusing on natural disaster victims and connecting businesses with federal contracts.

Over the years, the SBA has expanded to provide additional resources for women, minorities, and veterans. It also recognizes the growing global economy and has grown to include support for businesses dealing in international trade.

SBA’s Role in the Small Business Ecosystem

How does the SBA fuel small business growth in the U.S.? The agency focuses on four core service areas.

•  Free business counseling: The SBA has its own offices in each state, as well as partner organizations like Small Business Development Centers, SCORE mentors, and Veterans Business Outreach Centers.

•  SBA-guaranteed business loans: In 2024, SBA-backed capital totaled $56 billion, a 22% increase from the previous year.

•  Home and business disaster loans: The SBA helped 17,900 homeowners and renters in recovering from natural disasters in 2024, along with 9,500 disaster loans to small business owners.

•  Federal government contracting: The SBA issued $9.2 billion in surety bond guarantees on small business bids and final contracts.

Major SBA Programs and Services

Here’s a more in-depth look at what defines the Small Business Administration, especially regarding guaranteed loans and federal contracts support.

SBA Loan Programs

The SBA has three types of business loans provided by third-party lenders and partially guaranteed by the agency.

•  7(a) loans: The largest SBA loan program, it provides up to $5 million of funding. Loan uses include acquiring or approving real estate, working capital, business debt refinancing, machinery and equipment, furniture, or change in ownership.

•  504 loans: Made through Certified Development Companies (CDCs), 504 loans can be used to purchase, build, or improve facilities, long-term machinery and equipment, or consolidate debt. The maximum loan amount is $5.5 million.

•  Microloans: These startup loans go up to $50,000 for new businesses that may not meet eligibility requirements for the other loan programs.

SBA-approved lenders may also offer SBA Express loans, which reduce the decision-making process to 36 hours. The maximum loan amount for this program is limited to $500,000.

Recommended: Equipment loans

Federal Contracting Assistance

The SBA oversees multiple programs that help small businesses win more than 26% of federal contracting budgets each year. Programs include:

•  Small Disadvantaged Business

•  Women-Owned Small Business Federal Contract program

•  Veteran contracting assistance programs

•  8(a) Business Development program

•  SBA Mentor-Protégé program

•  Joint Ventures

•  HUBZone program

•  Natural Resource Sales Assistance program

The SBA also offers counseling through procurement center representatives and commercial market representatives, with regional offices across the country.

Entrepreneurial Development Resources

The Office of Entrepreneurial Development oversees the SBA’s counseling network and resources. This includes Small Business Development Centers (SBDCs), which have 900 service centers that help small business owners.

There are also over 100 Women’s Business Centers that provide resources specifically for female founders and owners on topics like federal contracts and access to credit.

Recommended: Business line of credit

How the SBA Benefits Small Businesses

The SBA helped over 103,000 small businesses in 2024 alone.

Access to Capital and Resources

In addition to guaranteeing small business loans, the SBA guarantees surety bonds on contracts up to $10 million. It will reimburse up to 90% of losses if a contractor defaults on the contract deliverables, making it easier for small businesses to qualify for these larger projects.

It also oversees credit risk management, which helps lending partners assess their portfolio performance and risk level. These insights help make the most of the SBA’s lending programs for borrowers and lenders.

Disaster Recovery Support

The SBA provides low-interest loans to individuals and businesses affected by declared disasters. Recent eligible events include Kentucky floods, California wildfires, Hurricane Milton, and Hurricane Helene.

The four types of disaster loans include:

•  Physical damage loans to help repair or replace assets.

•  Mitigate assistance to help prevent future damage in similar events.

•  Economic Injury Disaster Loans to provide businesses with operating expenses.

•  Military reservist loan for businesses with employees on active duty leave.

How to Access SBA Resources

The SBA has a large online library of resources for every stage of business, including planning, launching, managing, and growing a new venture. There are also online training sessions with free courses, discussion guides, and more.

Working with Local SBA Offices

Search for local SBA offices to get localized expertise on your business questions. Plus, district offices host online and in-person events on popular topics so you can grow your business acumen at no cost.

The Takeaway

Whether you’re looking for business support resources, financing, or disaster relief, the SBA is a wide-reaching federal agency that makes a big impact. Looking for faster funding opportunities? Explore multiple small business loan options from SoFi.

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 types of businesses qualify for SBA assistance?

There are a few SBA loan eligibility requirements including being an operating business, operating for profit, being located in the U.S., and remaining under the size requirements.

How do I apply for an SBA loan?

You must apply directly with third-party lenders that offer SBA loans. For 504 loans, you must apply with a community development corporation.

What’s the difference between SBA loans and traditional bank loans?

SBA loans tend to have more flexible eligibility criteria than bank loans because the federal government guarantees them.

Does the SBA provide grants to small businesses?

No, the SBA only provides grants to nonprofits, resource partners, and educational organizations.

How can the SBA help during economic crises or natural disasters?

The SBA offers low-interest loans after declared disasters. These are available for business owners, homeowners, and renters.

Photo credit: iStock/jacoblund

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.

SOSMB-Q125-028

Working capital is the money your business can access quickly to cover day-to-day operating expenses like salaries, inventory, and rent. Calculating your working capital and keeping a close eye on it is important because you want to make sure you always have enough available cash to cover your financial obligations.

Read on for a closer look at working capital, including what it is, how to calculate it, and what it means if your company has negative working capital.

What Is Working Capital?

By definition, working capital is the difference between your business’s current assets and current liabilities.

Current assets are any assets that could be turned into cash within the year and can include:

•  Cash in checking and savings accounts

•  Mutual funds, bonds, stocks, and exchange-traded funds (ETFs)

•  Inventory

•  Accounts receivable

Current liabilities are short-term financial obligations that a business must settle within one year or its operating cycle, whichever is longer. Liabilities can include:

•  Accounts payable

•  Rent

•  Utilities

•  Supplies

•  Loan payments

•  Taxes

Because working capital is the difference between your business’s current assets and liabilities, it’s a measure of liquidity. Your working capital is the money that you have at hand and can use for expenses that can and likely will come up.

If you’re ever in the market for a small business loan, a lender will likely look at your company’s working capital since it tells them how likely it is that you will be able to repay your debts.

💡 Recommended: 15 Types of Business Loans to Consider

Strategic Importance

Working capital plays a critical role in a company’s financial health and operational efficiency. It ensures that a business can meet its short-term obligations and maintain smooth day-to-day operations. Strategically managing working capital can improve profitability, resilience, and growth potential.

Key strategic benefits of working capital include:

•  Liquidity management: Ensures the company can cover day-to-day expenses like payroll, rent, and supplies.

•  Operational efficiency: Supports uninterrupted operations by balancing inventory and supplier payments.

•  Business agility: Enables quick responses to market changes or unexpected expenses.

•  Creditworthiness: A healthy working capital position improves the company’s ability to secure loans or business lines of credit.

•  Investment readiness: Frees up funds for reinvestment in growth initiatives such as R&D, expansion, or acquisitions.

•  Risk mitigation: Acts as a financial cushion during economic downturns or seasonal slowdowns.

Effective working capital management is essential for both stability and scalability in business.

Formula for Working Capital

Depending on why you’re figuring out your working capital, there are several ways to calculate it.

If you want to know how much working capital you have as a cash figure rather than a ratio, you simply subtract current liabilities from current assets. That way you get a dollar value for the liquid assets you’d have available after paying off current liabilities.

First, start by adding up your current assets.

Then, separately, add up your current liabilities.

Next, use the following formula:

Working Capital = Current Assets – Current Liabilities

Let’s say, for example, that your company has $300,000 in current assets and $100,000 in current liabilities. Then the following would be your calculation:

Working Capital = $300,000 – $100,000 = $200,000

Adjustments to the Working Capital Formula

The terms working capital and net working capital are often used interchangeably. However, sometimes analysts will use a more narrow definition and exclude most types of assets:

Net Working Capital = Accounts receivable + Inventory – Accounts Payable

In this case, let’s say you have $150,000 that’s owed to you by your clients and $150,000 in inventory. Assuming you owe $100,000 to suppliers, your net working capital is $200,000.

Net Working Capital = ($150,000 + $150,000) – $100,000 = $200,000

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How to Figure Out Working Capital Ratio

The working capital ratio (also called current ratio) is a way to look at how much you have in current assets in comparison to how much you have in current liabilities. It simply involves dividing your business’s current assets by its current liabilities.

Step-by-Step Calculation

To calculate working capital ratio, start by adding up your current assets.

Then, separately, add up your current liabilities.

Working Capital Ratio = Current Assets / Current Liabilities

Let’s say, again, that your business has $300,000 in assets and $100,000 in liabilities.

To calculate your working capital ratio, you would do the following:

Working Capital Ratio = $300,000 / 100,000 = 3

A working capital ratio greater than one says that your current assets are greater than liabilities (something likely to appeal to lenders or investors). A lower ratio means cash is tighter, so a slowdown in sales could cause a cash flow issue.

In the above example, the ratio is 3, which is on the high end. This could be a sign that the company is holding on to too much cash when it could be investing it back into the business to fuel business growth.

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Positive vs. Negative Working Capital

When you’re working to build business credit, you’ll likely want your business to have positive working capital. That means that the company has enough assets that could be quickly cashed out to cover all of its liabilities. It also means it’s more likely to be appealing to lenders as a loan applicant.

However, it’s also possible for a small business to have negative working capital. In this case, when you subtract liabilities from assets, you have a negative number. This might indicate that you’ve taken on more debt than you can afford or that your assets aren’t being used wisely.

If your business has negative working capital, you might find it difficult to qualify for a small business loan. You may need to pay a higher interest rate or make a larger down payment since the lender will likely perceive you as a greater risk.

Recommended: 6 Step Guide to Getting a Small Business Loan

Is Negative Working Capital Always Bad?

It’s normal for a company’s working capital to rise and fall as it handles its investments and expenses. A short-lived period of negative working capital usually isn’t a problem and can be easily turned around. It can simply indicate that the company had to make a large cash outlay or had a substantial increase in its accounts payable as a result of a large purchase of products and services from its vendors.

If negative working capital becomes a long-term issue, though, it can be a cause of concern, signaling that the company is struggling to make ends meet.

Context and Nuances

The implications of negative working capital depend heavily on the context of the industry, the company’s operating cycle, and overall financial health.

In industries like retail and restaurants — where companies receive cash up front but pay suppliers later — negative working capital can actually be a sign of operational efficiency. These businesses turn over inventory quickly and have minimal cash tied up in receivables or unsold goods.

However, for companies with long sales cycles, large inventories, or slow customer payments, negative working capital may signal liquidity problems. It could indicate an overreliance on short-term financing or difficulty converting assets into cash, leading to potential issues with meeting payroll, debt payments, or vendor obligations.

While negative working capital is not inherently bad, its impact depends on how it’s managed and the nature of the business. It’s crucial to evaluate trends over time and compare them to industry norms to determine whether it’s a red flag or a strategic advantage.

How Changes in Working Capital Affect Cash Flow

When you’re trying to understand working capital, it’s helpful to consider cash flow, too. That’s the cash and cash equivalents that flow in and out of your company.

Investors and lenders often look for a positive cash flow, meaning that your business is taking in more cash than it’s spending. This shows that your liquid assets are growing, so you can easily pay your liabilities.

Financial Dynamics

Working capital and cash flow can impact one another.

For example, let’s say you decided to invest in commercial real estate for your business. Your cash flow would decrease because you’ve put some of your cash down on the property and taken out a loan for the rest. Your working capital would also decrease because some of the cash you included in your assets would be reduced. However, even though you took a loan out for the property, that’s a long-term liability rather than a current liability, so nothing would change for current liabilities in your working capital formula.

To take another example, if you were to sell a property, this would increase your cash flow and your working capital. That’s because you would have increased your available cash.

Predictive Analysis

Predictive analysis also plays a crucial role in understanding how changes in working capital affect a company’s cash flow. By analyzing trends in accounts receivable, inventory, and accounts payable, businesses can forecast future cash needs and identify periods of potential liquidity stress or surplus.

For instance, if a company notices a consistent increase in receivables without a corresponding rise in revenue, it may predict future cash shortfalls due to delayed customer payments.

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The Takeaway

Understanding and managing working capital is essential for maintaining a company’s financial health and operational efficiency. It measures a business’s ability to cover short-term obligations and sustain day-to-day operations. By calculating working capital — current assets minus current liabilities — businesses can assess their liquidity and make informed decisions about cash flow management.

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 working capital calculated?

To calculate working capital, you subtract your current liabilities (what you owe) from your current assets (what you have). This tells you whether you have enough cash to cover your short-term expenses and debts.

What is an example of working capital?

Working capital is the difference between a company’s current assets and current liabilities. For example, if you have $300,000 in current assets and $100,000 in current liabilities, your working capital would be:

Working Capital = $300,000 – $100,000 = $200,000

Why is working capital important?

Working capital provides insight into a company’s liquidity, operational efficiency, and short-term financial health. A high working capital ratio indicates that you have enough assets to cover your debts, and then some. A low ratio might suggest that you have more debt than you can afford. Lenders may look at how much working capital you have to determine how risky you are as a borrower.

Does working capital change over time?

Yes, working capital changes over time because a company’s current liabilities and current assets will fluctuate over the course of a year.

How can businesses improve their working capital?

Businesses can improve working capital by optimizing inventory levels, accelerating accounts receivable collections, and negotiating longer payment terms with suppliers. Reducing unnecessary expenses and increasing sales revenue also help.

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-Q225-001

The business cycle is a period of time during which the economy expands, peaks, contracts, and bottoms out. Then the cycle repeats itself.

Business cycles are relevant on both a macroeconomic and a microeconomic level, which means your business experiences them along with the larger economy in which it operates. Understanding the business cycle can help you identify economic trends and changes and make informed decisions regarding your company’s finances.

Here’s a closer look at the business cycle, including how it works, how it can impact your business, and examples of the business cycle in action.

Business Cycle Defined

By definition, the business cycle represents economic growth and decline through distinct phases. These phases often occur in an identifiable pattern where one phase tends to follow the other. They typically include expansion, peak, recession, and trough.

Financial professionals and organizations measure the business cycle primarily by the increases and decreases in the gross domestic product (GDP), along with the influences of trade and production costs. A business cycle is completed when it goes through a single boom and a single contraction in sequence. The time period to complete this sequence is called the length of the business cycle.

Governments try to manage business cycles by spending, raising or lowering taxes, and adjusting interest rates.

Economic Context

During expansion, the economy grows as businesses invest, hire more workers, and consumers spend more. This upward trend continues until the economy hits a peak, where growth slows due to constraints such as inflation or market saturation.

In the contraction phase, economic activity declines — businesses reduce production, lay off workers, and consumer spending falls. If this downturn is prolonged or severe, it may become a recession. Eventually, the economy reaches a trough, the lowest point in the cycle, before beginning to recover.

The business cycle is influenced by various economic factors, including monetary policy, fiscal policy, consumer confidence, and external shocks such as geopolitical events or natural disasters. Understanding the economic context of the business cycle helps policymakers and businesses anticipate changes and make informed decisions.

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How the Business Cycle Works

As consumer confidence starts to build, the economy experiences an expansion. When businesses are increasing production, they need more employees. As a result, more people are hired, there is more money to spend, and businesses make more profits and can focus on growth. Economic expansion continues until circumstances occur that cause production to slow.

If business production slows, not as many employees are needed. As a result, consumers have less money to spend and businesses reduce spending on growth. This results in an economic contraction. When the total output of an economy declines (recession) and ultimately bottoms (trough), we then enter the next cycle’s expansion phase.

The average business cycle in the U.S. is about six years.

Key Economic Indicators

Understanding the business cycle is essential for gauging the health and direction of an economy, and key economic indicators provide valuable insights into where the cycle may be headed. These indicators include:

•  Gross Domestic Product (GDP): Measures the overall economic output and growth.

•  Unemployment rate: Indicates labor market health; rising rates often signal contraction.

•  Inflation rate: Tracks changes in consumer prices; high inflation may precede a downturn.

•  Consumer confidence index: Reflects consumer sentiment and spending intentions.

•  Interest rates: Set by central banks to control inflation and stimulate or cool the economy.

•  Retail sales: Measures consumer spending trends and economic momentum.

•  Business investment: Indicates future economic confidence and expansion plans.

•  Housing starts: New residential construction signals demand and broader economic activity.

Interconnected Factors

The business cycle is driven by a complex web of interconnected factors that influence economic expansion and contraction. These include consumer spending, business investment, government fiscal policies, and global trade dynamics. Changes in interest rates, inflation, and employment also play critical roles, as they affect both supply and demand across industries.

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Stages of the Business Cycle

While there are four main phases in a business cycle, a business cycle can actually consist of six distinct stages, involving both high and low points.

There is no set length of time for each stage; some could be short-term, while others could last many years. In some cases, the stages of the business cycle may only be able to be identified in retrospect.

The stages of a business cycle can include:

1. Expansion

During a period of expansion, business is booming for the majority of companies. During this stage, companies will often hire more employees, take out small business loans, and invest in growth. Believing that employment is steady and income assured, consumers will generally spend more, and supply and demand match up fairly evenly. Prices may start to rise now.

2. Peak

The peak stage is when the economy hits a saturation point. Production and prices have reached their limit and the market can’t bear any more increases. Consumers may cut back on their spending because they can’t afford to pay the increased prices. This is the turning point — with no room for growth left, there’s nowhere to go but down. A contraction is on the way.

3. Recession

Once that peak has been reached, the business cycle enters a contraction, or recession. At this stage, people don’t buy as many things. Often businesses do not notice the decrease in demand instantly and go on producing, which often creates a situation of excess supply in the market. Prices tend to fall and companies may pull back on hiring or investing in growth, and may even lay off employees, causing a rise in unemployment.

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4. Depression

If growth continues to decline, the economy can reach the depression stage. In this stage, the economy’s growth rate becomes negative. There is extensive depletion of national income and expenditure. Companies may lay off even more employees and find ways to drastically reduce spending. Production of products drops due to lack of demand, and prices continue to fall. The economy eventually reaches the trough.

5. Trough

The trough in the business cycle is the lowest point of economic activity before a recovery begins. It marks the end of a recession and the transition into an expansion phase. During the trough, key indicators like GDP, employment, and consumer spending hit their weakest levels.

At this stage, businesses may reduce production, unemployment is typically high, and confidence is low. However, it’s also when conditions begin to stabilize, setting the foundation for renewed growth as consumer demand slowly returns and investments pick up.

6. Recovery

At last, there is a turnaround in the economy as it begins to recover. Consumers and investors begin to feel more confident about the economy, and spending picks up since prices are still low.

Companies may start to spend on growth again, replacing depreciated capital and making new investments in the production process. Employment begins to rise and, due to accumulated cash balances with banks, lending also shows positive signs. Recovery continues until the economy returns to steady growth levels.

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Pros and Cons of the Business Cycle as a Model

While tracking the larger business cycle in the country can be beneficial for your business financial planning, there are some drawbacks, as well. Here’s a look at the pros and cons of using the business cycle as a model when making business decisions.

Theoretical Strengths

Using the business cycle as a model for decision-making allows businesses to align strategies with broader economic conditions. The cyclical framework helps organizations anticipate shifts in demand, interest rates, and consumer behavior, enabling proactive planning.

If businesses are looking to apply for a small business loan or bring on an investor, they may be able to use the business cycle to dictate where interest rates are headed. If rates are currently low, it can be a sign to take advantage of borrowing before rates rise.

Limitations and Criticisms

While the business cycle provides a useful framework, relying too heavily on it for decision-making has limitations. One major drawback is its unpredictability — economic cycles don’t follow a fixed timeline, and external shocks (like pandemics or geopolitical events) can disrupt expected patterns.

Additionally, the business cycle is a broad, macro-level model that may not reflect industry-specific or regional variations. A sector might thrive during a national downturn or struggle during expansion due to unique factors. Businesses that rely on the generalized stages of the cycle may overlook nuances in their specific markets, leading to oversimplified strategies or inadequate responses to localized conditions.

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Market vs Business Cycles

Business cycles and market cycles may sound like the same thing but, technically, they are different. A market cycle refers to different growth and decline stages of the stock market, whereas the business cycle looks at the economy as a whole.

The two cycles are related, however. The stock market is affected by, and often mirrors, the phases of a business cycle. During the contraction stage of the business cycle, investors tend to sell their holdings, leading to a drop in stock prices. This is known as a bear market. During an expansion phase of the business cycle, investors often buy up stocks, causing prices to go up. This is known as a bull market. Eventually, the economy, and the market, will pick back up again, heading toward a bull market, and the cycle repeats.

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Measuring Business Cycles

The National Bureau of Economic Research (NBER), a nonprofit organization, defines and measures business cycles in the U.S. The NBER actually has a Business Cycle Dating Committee that is responsible for determining the start and end of a business cycle.

NBER primarily relies on quarterly GDP growth rates to identify a business cycle. However, it will also look at other financial data, including income, retail sales, and manufacturing output.

The NBER does not release this information until analysts thoroughly evaluate it. This means you may not know when a new business cycle begins until well after it’s started. However, you can usually take note of a few key indicators (such as interest rates, total employment, and consumer spending) to see where you are in the business cycle.

Statistical Methods

Commonly used statistical methods for measuring business cycles include:

Turning Point Analysis: This method identifies peaks and troughs in economic activity using historical data. It is often applied in conjunction with composite indexes (like the Leading Economic Index) to define business cycle phases and turning points, as done by institutions such as the NBER.

Hodrick-Prescott (HP) Filter: This technique decomposes economic time series into trend and cyclical components. It helps economists and analysts visualize fluctuations around the long-term growth path, making it easier to detect expansions and recessions.

Moving Averages: By averaging data over a specific time period, this method smooths out volatility and highlights underlying trends in indicators like GDP or industrial production. It is simple and widely used in preliminary cycle assessments.

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Example of the Business Cycle

Understanding how the business cycle works in real-world scenarios helps illustrate its impact on economies, businesses, and consumers.

Historical Case Studies

One famous example of the business cycle is the Great Depression, which began in 1929. Before the economy began to contract, the GDP rate was high and unemployment was low, thanks to new developments like the airline industry. The expansion phase reached a peak, and then the economy began to decline — unemployment rose, GDP fell, and the Depression occurred. The economy hit the trough around 1933, after which it began to recover.

A more recent business cycle example is the Great Recession. The U.S. economy started an expansion period in 2000, and then, beginning in late 2007, it went through the largest economic downturn since the Great Depression. The downturn was triggered by the bursting of a housing bubble, which led to a global financial crisis. Following a trough in June 2009, the economy began to recover and expand, reaching a peak in February 2020.

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The Takeaway

The business cycle refers to the rise and fall in economic activity caused by factors like interest rates, trade, production costs, and investments. A business cycle is completed when it goes through a single boom and a single contraction in sequence. The extreme points are the peak and the trough.

While economic forecasts and modeling aren’t perfectly reliable, combining information about business cycles with what you know about your particular industry and company can help you to prepare for shifts in the economy before or soon after these changes occur. For example, understanding where you are in a business cycle can also help you decide if it’s a good time to apply for a small business loan, make capital investments, or hire more employees.

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 many stages are in the business cycle?

Generally, the business cycle consists of four phases: expansion, peak, contraction, and trough. These phases represent the natural rise and fall of economic activity over time.

What are the stages of the business cycle?

The business cycle includes four main stages: expansion, peak, contraction, and trough. Expansion is marked by growth in economic activity, followed by a peak at the highest point. Contraction involves slowing growth or recession, leading to the trough, the cycle’s lowest point before economic recovery and a new expansion begins.

What is the purpose of the business cycle?

The purpose of a business cycle is to track economic activity and forecast the direction of the economy. The business cycle helps the government determine fiscal policy and guides the Federal Reserve in setting interest rates. It also influences how businesses and consumers spend, invest, and access credit.

How do global events impact the business cycle?

Global events such as pandemics, wars, or economic crises can significantly disrupt the business cycle. They may trigger recessions by reducing consumer demand, increasing uncertainty, and straining supply chains. Conversely, stimulus measures or recovery efforts can boost economic activity, sparking expansion. These events often reshape industries and alter long-term growth trends.

Can the business cycle be predicted accurately?

While economists use indicators to forecast business cycle trends, predicting them with complete accuracy is challenging. Factors like consumer behavior, global events, and policy changes introduce uncertainty. Though models can identify patterns and turning points, unforeseen shocks often disrupt predictions, making business cycle forecasts educated estimates rather than certainties.

Photo credit: iStock/cagkansayin

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.

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