A working capital line of credit is a type of short-term financing that helps businesses cover their operating expenses, such as rent, payroll, or inventory. It is not intended for large, one-off expenses, like asset acquisitions or opening a new location.
It provides flexible access to funds, allowing businesses to borrow as needed and repay over time. Interest is only charged on the amount used. If your business has seasonal cycles or sometimes experiences gaps in cash flow, you might benefit from a working capital line of credit.
Here’s a closer look at how these credit lines work, including their pros and cons, eligibility requirements, and how they compare to other loan products, such as a working capital loan.
Key Points
• A working capital line of credit provides ongoing access to funds as needed. Businesses only pay interest on the amount drawn.
• It helps businesses cover operational expenses like payroll, rent, and inventory.
• Working capital lines of credit help maintain liquidity during cash flow gaps or unexpected financial demands.
• Working capital loans provide a lump sum of cash upfront and typically come with fixed monthly payments until the loan is repaid.
• To qualify for a working capital line of credit, lenders typically like to see a minimum annual revenue of $50,000 and six months of business history. Minimum credit scores vary by lender, but generally those with higher scores will receive better rates.
What Is a Working Capital Line of Credit?
A working capital line of credit is a type of revolving credit that businesses can use for operating expenses. It can help cover costs such as rent, utilities, payroll, and inventory until accounts receivable have been collected as part of the cash conversion cycle.
Unlike a working capital loan, you don’t get a lump sum of cash upfront. Instead, you are approved for a certain credit limit. You can then draw funds as you need them (up to the limit) and will only pay interest on the amount you draw. As you pay your balance down, the money becomes available once again.
The schedule to repay a line of credit will vary depending upon the lender, but is often weekly or monthly. On top of interest charges, a working capital line of credit may also come with fees, such as an annual fee and/or transaction fees.
Working capital lines of credit can be secured (which requires collateral) or unsecured (no collateral required).
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What Is Working Capital?
Working capital is the difference between a company’s current assets and its current liabilities. Current assets are anything a business owns that could be converted to cash within a year. Current liabilities are any debts and obligations that are due within the year. Whatever is leftover after subtracting current liabilities from current assets is a business’s working capital.
Working capital provides an indication of a company’s short-term health. It also tells you what your business has available to spend on day-to-day operating expenses.
Operating expenses may include:
• Rent
• Utilities
• Payroll for staff
• License fees
• Accounting and legal fees
• Bank charges
• Marketing
• Vehicle expenses
• Travel
• Office supplies
• Property taxes on real estate
• Research
• Repairs
Because operating expenses can be high, any dip in cash flow (due to delayed customer payments, a seasonal slump in sales, or an emergency expense) can hurt a business’s ability to generate revenue. As a result, it’s important that businesses are always able to cover all of their operational costs.
How to Calculate Working Capital
Working capital is calculated using the following formula:
Current assets include items like cash, accounts receivable, and inventory, which can be converted to cash within a year. Current liabilities include debts and obligations that must be paid within the same period, such as accounts payable and short-term loans.
A positive working capital indicates that a business has sufficient assets to cover its short-term liabilities, ensuring smooth operations. A negative working capital means liabilities exceed assets, which could lead to liquidity problems or challenges in meeting financial obligations. Those with a negative working capital could consider a working capital line of credit to fill in the gaps where funding falls short.
How Working Capital Lines of Credit Work
Here’s a more in-depth look at how working capital lines of credit work.
How Much Can You Borrow?
A working capital line of credit can range anywhere from $1,000 to over $1 million. How much your business can borrow will depend on a variety of factors, including your credit score, revenue, and existing debt. Keep in mind that your credit line is the maximum you can borrow before you need to pay off your balance. However, you only have to pay back the actual amount you borrow.
Rates
Working capital line of credit rates vary depending on the lender and your qualifications as a borrower. Some lenders will quote a weekly rate, while others will provide an annual percentage rate (APR). APRs include interest as well as fees, so it’s a good way to compare credit lines offered by different lenders apples to apples. APRs for working capital lines of credit can range anywhere from 10% to 80%.
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Term Lengths
The term length, or draw period, for a working capital line of credit can range between six months and five years. Since it’s revolving credit, each time you repay any amount you’ve borrowed, the money once again becomes available. When the term is up, you can no longer draw funds. However, if you’ve been making on-time payments, the lender may allow you to renew your line of credit.
Funding Speed
This type of loan funds quickly — often within a few days. The actual funding speed will depend on the lender and the size of the credit line. Online lenders tend to fund faster than banks, and smaller credit lines typically get approved and fund more quickly than larger credit lines.
Working Capital Loans vs Lines of Credit
Both working capital lines of credit and working capital loans can be used to cover operating expenses. However, these two lending products work in different ways. Here’s a side-by-side comparison.
| Working Capital Loan | Working Capital Line of Credit | |
|---|---|---|
| Loan size | Typically larger | Typically smaller |
| Repayment structure | Dispersed as a lump sum you repay in equal monthly installments | Revolving credit that lets you pay off the balance and borrow more |
| Collateral requirements | Typically required | Sometimes required |
| Qualification requirements | Harder to qualify for | Not as hard to qualify for |
| APRs | Tend to be higher | Tend to be lower |
Pros and Cons of Working Capital Lines of Credit
| Pros of Working Capital Lines of Credit | Cons of Working Capital Lines of Credit |
|---|---|
| Fast funding times | Can cost more than other loan products |
| Smooths out dips in cash flow | May come with fees |
| Can use for any type of operating expense | May require collateral |
| Money becomes available again as payments are made | May not help you build business credit |
Pros of Working Capital Lines of Credit
On the plus side, this type of small business loan can help improve cash flow by providing a pool of funds you can pull from whenever you need them. These lines are also fast to fund. And, as long as you’re investing in your business’s operating costs, you can generally use the funds however you see fit.
In addition to funding quickly, a line of credit offers revolving funds, meaning once you fully pay off your balance, the full credit line will be available again. A working capital line of credit can also serve as an emergency fund — it’s there if you need it, but you won’t pay any interest if you don’t.
Cons of Working Capital Lines of Credit
On the downside, these loans can be costly. They are considered a short-term type of funding, and generally short-term loans are more costly than long-term loans. You may also have to pay small business loan fees, such as an origination fee, monthly maintenance fee, annual fee, and transaction fees.
In some cases, you may also need to put up business collateral. Since a line of credit is a short-term liability, lenders typically ask for short-term assets, such as accounts receivable or inventory. If you’re unable to repay the line, the lender will assume the ownership of your collateral.
Another potential downside is that getting this type of loan and making timely payments on your credit line might not help you build business credit, since some online lenders do not report these loans to the credit bureaus.
Working Capital Line of Credit Requirements
Lenders offering working capital lines of credit generally have the following requirements:
• Revenue: Minimum amounts will vary with each lender, but you generally need at least $50,000 in annual business revenue.
• Age of business: Typically, the longer you’ve been in business, the more likely you are to qualify for a working capital line of credit. Banks generally prefer to work with businesses that have been in business for at least two years. However, some online lenders require only six months.
• Collateral: Having an asset of value that you can put up as collateral can help a business not only get approved for a credit line but also get approved for a higher line of credit and a lower interest rate. It may be possible to get an unsecured business line of credit, but it will likely come with a higher APR.
• Credit score: Lenders usually look at both personal and business credit scores to determine the creditworthiness of a borrower. Typically, you’ll need a credit score of at least 500 to get a working capital line of credit.
How to Apply for a Working Capital Line of Credit
Applying for a working capital line of credit involves several key steps:
1. Assess your financial needs. Determine the amount of credit required to support your business operations and ensure it aligns with your working capital requirements.
2. Select a lender. Research and choose a lender that offers working capital lines of credit with terms favorable to your business. This could be a traditional bank, credit union, or online lender.
3. Prepare financial documentation. Gather essential documents, such as financial statements, tax returns, business licenses, and a detailed business plan. These will be crucial during the application process.
4. Submit the application. Complete the lender’s application form accurately, providing all required information and documentation to support your request.
5. Review and negotiate. Upon receiving an offer, carefully review the terms and conditions. Negotiate if necessary to ensure the credit line meets your business needs.
6. Finalize the agreement. Once agreed upon, sign the contract and set up the line of credit, ensuring you understand the repayment schedule and any associated fees.
Once everything is signed and approved, funds are typically dispersed within one to three business days.
Alternative Ways to Finance a Business
A working capital line of credit is one way to cover a company’s everyday expenses and even out cash flow. Here are some other types of financing options you may want to consider.
Small Business Loans
A small business term loan gives you access to a lump sum of funds you then pay back (plus interest) in regular installments over the term (length) of the loan. Banks typically offer the best rates and terms but have relatively strict qualification requirements, including at least two years of business history and minimum annual revenues. Online lenders generally have more flexible qualification criteria and are faster to fund, but rates are usually higher and loan amounts can be smaller.
Recommended: What to Know About Short-Term Business Loans
Startup Loans
A startup business loan is another option that could help with your working capital needs. These loans can help new entrepreneurs cover a range of business costs, including equipment, inventory, payroll, utilities, and insurance. The U.S. Small Business Administration’s microloan program, for example, offers loans of up to $50,000 for small businesses looking to start or expand. Some online lenders will also offer loans to new businesses.
Merchant Cash Advances
If your business has high credit card sales volume and you need quick access to cash, you might look into a merchant cash advance (MCA). With this type of financing, you receive funds as a lump sum from an MCA provider and repay the advance from future sales. Typically, the lender will automatically deduct a portion of your credit card sales, usually each business day. MCAs are generally easy to qualify for, but costs typically run significantly higher than traditional small business loans.
The Takeaway
A working capital line of credit is a short-term funding option you can use to cover everyday business expenses. It’s a revolving line of credit, meaning you can use the funds up to your credit limit, pay them back (with interest), and use them again.
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 would you calculate a working capital line of credit?
You calculate how much interest you’ll pay per month on a working capital line of credit using the amount you draw, not the full credit line.
If the lender gives you an annual percentage rate (APR), you would multiply your balance (draw) by the APR, then multiply that number by the number of days in a given month. You then take that number and divide by 365. The formula looks like this:
(Principal Balance X Interest Rate X Days In Month) / 365
Are working capital loans and lines of credit different?
Yes. With a working capital loan, you receive the full amount of the loan upfront and then repay it (plus interest) in regular installments over the term of the loan.
A working capital line of credit, by contrast, gives you access to a certain credit limit. You can take what you need (up to your credit limit), and only pay interest on the amount you borrow. Once you repay the funds, they are available to borrow again.
How are working capital loans and term loans different?
A working capital loan is intended to be used for operating expenses, such as payroll, rent, or inventory. A term loan, on the other hand, can be used for working capital as well as other business expenses, such as purchasing large assets.
Photo credit: iStock/Charday Penn
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