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Cash flow is the amount of money in and out of your business. Assessing cash flow is an essential step in understanding how operating expenses impact your business’s bottom line.

Many companies use accounting software to do the job. But, depending on the complexity of your business, it may be possible to calculate cash flow using a spreadsheet and some basic math formulas.

Read on to learn more on cash flow, including how to calculate cash flow and how to manage cash flow problems.

What Is Cash Flow?

Cash flow refers to the movement of money in and out of a business over a specific period. It measures the company’s liquidity and ability to meet financial obligations.

Positive cash flow occurs when more money is coming in than going out, while negative cash flow indicates the opposite. Effective cash flow management ensures businesses can cover expenses like payroll, rent, and loan repayments while investing in growth.

Cash flow is typically divided into three categories: operating, investing, and financing activities, each contributing to a comprehensive view of a company’s financial health.

Why Understanding Cash Flow Is Important

Calculating cash flow lets you see how your business’s expenses (outflows) compare to your company’s income (inflows). A business generally needs to be cash flow positive, meaning monthly revenue exceeds your operating expenses, to maintain a sustained, profitable existence.

Understanding your cash flow cycle also helps you make financial projections, which can inform your decision-making process. It includes:

•   Anticipating inventory needs, including how to pay for supplies

•   Determining if your prices are reasonable

•   Projecting your fixed expenses versus seasonal revenue

Your cash flow projections can help you figure out how you’re going to finance the lean months while being fully prepared for your busy months.

When you’re cash flow positive, you’re likely offering the right services at the right price. But if your revenue isn’t covering your operating expenses, it may be time to rethink your business structure.

No matter what type of business you operate, your cash flow is one of the most critical financial components to understand. Not only does it help you manage your business’s accounts, but it’s also often required by lenders and investors when you apply for financing.

Recommended: Getting a Cash Flow Loan for Your Small Business

How Is Cash Flow Calculated?

At its core, cash flow involves subtracting monthly expenses from your monthly balance and income. The money you can transfer to the next month’s balance is your cash flow.

More complex businesses can identify separate categories for cash flow from operations, investing, and financing.

Here, we’ll discuss a few different cash flow formulas: operating cash flow, free cash flow, cash flow forecasting, and discounted cash flow.

Recommended: Net Operating Working Capital

Operating Cash Flow Formula

Your operating cash flow looks at whether your company is making a net profit from its core business operations. It hones in on cash inflows and outflows from a company’s core operations and ignores cash flows related to outside investing or non-core operations.

Any revenue your company has brought in through sales is called your “cash in.”

The expenses, such as rent, payments on small business loans, credit card payments, taxes, salaries, and manufacturing, are called “cash out.”

To calculate your operating cash flow, take the following steps each month:

1.    Add the starting balance and revenue to determine your cash in.

2.    Add up all expenses to determine cash out.

3.    Subtract cash out from cash in.

Your remaining amount is your operating cash flow for the month.

(The formula can include other things for more complex businesses, such as depreciation, but let’s keep things comparatively simple for now.)

Recommended: Business vs Personal Bank Account: What’s the Difference?

Operating Cash Flow Example

Let’s look at an example for an imaginary company:

XYZ Retail had a balance of $100,000 roll over from June into July. In July, XYZ Retail grossed $400,000 in revenue. Its total cash in is $500,000.

XYZ Retail’s expenses for the month totaled $250,000, and taxes on the profit amounted to $62,500. Its total cash out is $312,500.

As the formula for operating cash flow is:

Cash In – Cash Out = Operating Cash Flow

XYZ Retail’s formula would look like this:

$500,000 – $312,500 = $187,500

Therefore, XYZ Retail has $187,500 of cash flow to roll over. The company will add the $187,500 balance to whatever revenue they make the next month.

Recommended: What Is a Variable Costing Income Statement?

Free Cash Flow Formula

Calculating your free cash flow allows you to determine how much spending money you have after determining operating cash flow and capital expenses.

Capital expenses are funds invested in the long-term life of your business and spent on larger scale purchases like trucks, large machinery, and building purchases. This differs from operating costs because those are day-to-day expenses such as salaries, smaller supplies (e.g., copiers and computers), and building rentals, not purchases.

Once free cash flow has reached an amount with which a business owner is comfortable, the owner typically uses the funds to make decisions about the future, including expansion or hiring additional people or an outside company to provide support.

There are a few ways to calculate free cash flow. However, the simplest takes the following steps:

1.    Determine operating cash flow (see the formula in the previous section).

2.    Add up capital expenditures.

3.    Subtract capital expenditures from operating cash flow.

There are other formulas for calculating free cash flow. But they’re usually for instances where a company hasn’t been closely monitoring its operating cash flow and capital expenditures.

However, if those have gone to the wayside, the formulas you could use in a pinch are:

•   (Net Operating Profit – Taxes) – Net Operating Capital Investment = Free Cash Flow

•   Sales Revenue – (Operating Costs + Taxes) – Operating Capital Investments = Free Cash Flow

Free Cash Flow Example

Let’s revisit the fictional company XYZ Retail.

At the end of July, XYZ Retail’s total operating cash flow was $187,500.

That same month, they made upgrades to their building to make it more ADA accessible. This would be a capital expenditure because those upgrades are permanent and can help with future success. The total capital expenditure amount was $53,050.

As the formula for free cash flow is:

Operating Cash Flow – Capital Expenditures = Free Cash Flow

XYZ Retail’s formula would be:

$187,500 – $53,050 = $134,450

This means the free cash flow is $134,450.

Cash Flow Forecast Formula

Calculating your cash flow forecast can help you plan month to month, quarter to quarter, or year to year by figuring out approximately how much money you’ll have on hand.

Forecasting cash flow is more complex than operating and free cash flows, as you need more details.

There are two methods of cash flow forecasting: Direct and indirect.

To calculate direct cash flow, take the following steps:

1.    Determine cash in.

2.    Determine cash out.

3.    Subtract cash out from cash in.

4.    Do this month over month to make an educated guess for the coming months.

Cash flow can wax and wane depending on the season. Therefore, something like a summer-only direct cash flow amount may not apply to the winter.

While this seems simple on the surface, this isn’t necessarily the case. You need to know precisely where all money is coming and going from. (Luckily, you can set up a spreadsheet to keep track of it, but you should update it frequently to ensure nothing gets missed.)

The indirect method of calculating cash flow forecast focuses on net income and factors affecting profitability — but not cash balance. It uses your profit and loss statements and balance sheet. To use this method, follow these steps:

1.    Get your current balance from your balance sheet. If you have previous ones, check those as well.

2.    Compare it to your profit and loss statements to get a decent estimate of your monthly cash in and cash out.

This method is more commonly used among people who don’t want to hire a bookkeeper or use accounting software or those with so many transactions that monitoring every single one is difficult.

Neither method is right or wrong; try out both to see which works best for you.

Cash Flow Forecast Example

American Express provides a cash flow forecast template , as well as an example of what it might look like.

Discounted Cash Flow Formula

Discounted cash flow (DCF) estimates the future value of a business based on projected cash flows. It can help determine whether an investment is likely to pay off in the long run.

The term “discounted” is there to account for inflation and the lower value of money received in the future compared to money received now.

The discount rate is usually a company’s weighted average cost of capital (WACC), which represents how much a company must pay to its investors and lenders.

(Note: The discount rate can also be an interest rate; it depends on the type of investment.)

The discounted cash flow formula looks like this:

DCF= ∑ CFt / (1+r)^t​​

CF = Cash flow

r = discount rate

t = time period

Discounted Cash Flow Example

Let’s put this into an example.

A potential investor in XYZ Retail wants to determine if they’ll see return on investment in three years if they invest $50 million now.

Let’s say XYZ’s cash flow (CF) for Year 1 is $20 million. Based on past performance, we calculate that future cash flow is expected to grow at a rate of 5% each year. So, for Year 2, CF will be $21 million and Year 3, CF will be $22.05 million.

Now, let’s say the WACC for XYZ Retail is calculated to be 4%, meaning 0.04 will be our discount rate (r).

Plugging it into the equation, we find:

DCF = 19,230,769.23 + 19,415,680.47 + 19,601,742.37

DCF = $58,248,192.07

In this case, the investor may see a return on their investment of $50 million in three years. However, it is very important to remember that DCF relies heavily on forecasting, meaning it is not going to be 100% accurate — or a 100% guarantee of a company’s future value.

Recommended: Net Operating Working Capital

Managing Cash Flow Problems

When handling business cash management, many companies experience cash flow hiccups. Frequently tracking and analyzing your finances can help you anticipate challenges and create proactive solutions. Here are five tips on how to better manage cash flow in your business:

Using Accounting Software

While calculating cash flow by hand is great, accounting software can help you keep a closer eye on where money is coming from and going to. Accounting programs can create invoices and track outstanding ones; they can also automatically break down expenses compared to actual cash brought in each month.

Hiring a Bookkeeper

A bookkeeper or accountant can bring to this the human touch that accounting software can’t. For instance, they can analyze the information, then break down the data into layman’s terms.

Small companies may not want or be able to invest in a full-time staff member, but some people do this on a part-time, freelance, or contract basis.

Refining Your Budget

Constantly analyze and refine your cash flow to ensure you have an effective operating budget in place. This can help businesses weather potential or anticipated downturns in business.

Increasing Revenue

Increasing revenue during a period of negative cash flow may require thinking outside of the box.

This might include running an alternative marketing campaign, expanding employee training, and finding creative ways to turn over inventory that isn’t selling well.

Applying for a Line of Credit

Depending on the nature of your cash flow issues and how long you expect them to last, applying for a business line of credit may be an option for getting an injection of capital. This is typically best used if you know what the problem and solution are and need a temporary fix.

Just like with any type of business financing, however, you’ll want to make sure you have a solid plan to repay your balance.

Other Important Financials to Know About

Your business’s cash flow statement is one of many critical financial snapshots reflecting your company’s health. However, there are other ways of monitoring financials, including balance sheets and income statements.

Balance Sheet

Your company’s balance sheet holds valuable information, including assets, liabilities, and details on owners/shareholders.

Assets include cash, inventory, and property. Liabilities include debt, expenses, and owners’/shareholders’ equity. This equity is particularly relevant if they’re paid retained earnings.

A balance sheet reveals important metrics such as your business’s debt-to-equity ratio and amount of working capital.

You typically need to provide your balance sheet any time you apply for business financing or pitch to new investors, along with other documents, so it’s a good idea to have this prepared for any such occasion.

Recommended: The Ultimate List of Financial Ratios

Income Statement

While your cash flow includes data from the business’s financing and investments, your income statement focuses solely on revenue and expenses over a set period. As a result, it can reveal trends in sales, production costs, and operating expenses.

Depending on the type of accounting used, the income statement may or may not be based on cash accounting.

For example, cash flow measures funds as they enter and leave your business accounts. But using an accrual accounting method, your income statement would reflect when orders are placed rather than paid for.

The Takeaway

Learning how to calculate cash flow is a vital step in understanding your finances. When combined with your balance sheet and income statement, cash flow can be used to keep track of profitable ventures and overspending. It’s wise to regularly review your cash flow to ensure everything is running smoothly.

Cash flow also plays a critical role in getting a small business loan because it shows lenders the company’s ability to repay debt. Strong, consistent cash flow indicates financial stability, reducing the risk for lenders.

If you’re seeking financing for your business, SoFi can help. On SoFi’s marketplace, you can shop top providers today to access the capital you need. Find a personalized business financing option today in minutes.

Get personalized small business financing quotes with SoFi's marketplace.

FAQ

What is an example of cash flow?

Cash flow refers to money moving in and out of your business. An example of cash flow is a small business receiving $10,000 in revenue from sales (inflow) while paying $4,000 for rent, $3,000 for salaries, and $2,000 for supplies (outflow) during a given month. The remaining $1,000 represents positive cash flow, which can be used for savings, investments, or loan repayments.

Does cash flow mean profit?

No, cash flow and profit are not the same. Cash flow refers to the money moving in and out of a business, while profit is what remains after all expenses are deducted from revenue. A business can have positive cash flow but still be unprofitable if expenses exceed revenue.

What is a healthy cash flow?

A healthy cash flow means that a business consistently generates more cash inflows than outflows, allowing it to cover operational expenses, repay debts, invest in growth, and maintain financial stability. It indicates strong liquidity and ensures the business can meet both short-term obligations and long-term financial goals without relying heavily on external financing.

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Photo credit: iStock/PeopleImages

SoFi's marketplace is owned and operated by SoFi Lending Corp. See SoFi Lending Corp. licensing information below. Advertising Disclosures: SoFi receives compensation in the event you obtain a loan through SoFi’s marketplace. This affects whether a product or service is featured on this site and could affect the order of presentation. SoFi does not include all products and services in the market. All rates, terms, and conditions vary by provider.

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.

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.

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.

SOSMB-Q324-057

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Yes, a business loan may impact your personal credit score. If you run a sole proprietorship or partnership, or if you personally guarantee the business account in any capacity, your personal credit score may be affected.

Read on to learn the different ways in which a business loan can affect your credit scores, and what you can do to keep business financing separate from your personal finances.

What Is Business Credit?

Business credit is based on your business’s credit history and is expressed in the form of business credit scores. Both your business credit profile and business credit scores give credit agencies, lenders, vendors, and suppliers an indication of how you handle your debts and your likelihood of paying them on time.

Building your business credit profile can pay off by giving you access to small business loans and other types of financing with favorable rates and terms.

How Does Business Credit Work?

In order to establish credit for your business, you need to first legally register it as a business entity. Once your business is registered, your business credit reports will be created when vendors, suppliers, or creditors report your company’s accounts and activity to a business credit bureau. This activity helps to generate the information that informs your business credit scores.

Difference Between Personal and Business Credit

While business and personal credit are two separate entities, the lines can sometimes get blurred.

Your personal credit score is linked to you through your social security number and uses information drawn from your personal credit reports. Your score reflects your funding and payment history, such as your use of credit cards or your record of paying off a student or personal loan, and can affect your access to future credit and what interest rates you pay. It may also be looked at by landlords and potential employers.

A business can have its own credit score, so long as it is a separate legal entity with a federal employer identification number (EIN). If you’re trying to get a business loan, some lenders may examine only your business credit history, which is reported by three major business credit bureaus: Experian, Equifax, and Dun & Bradstreet. Others may look at both your business and personal credit scores.

Recommended: Personal Loan vs Business Loan: Which Is Right for You?

What Types of Business Activities Can Affect Personal Credit?

In some cases, your business credit can affect your personal credit. Let’s take a closer look.

Business Credit Card Use

When you apply for a business credit card, the lender will typically perform a hard credit inquiry into your personal credit. Any hard credit pull can potentially lower your personal credit score by a few points, so you may see a small, temporary dip in your personal credit scores.

Once you’re using your business credit card, some activities will impact only your business credit, while others may affect both personal and business credit scores. It all depends on what the credit card issuer chooses to report and which credit agencies they choose to report to.

Some business credit card issuers report all of your account activity to the three major consumer credit bureaus (TransUnion, Equifax, and Experian), while others will only report negative information to those bureaus, such as being more than 30 days late on a payment.

Most Business Debt

Any type of business loan could impact your personal credit if you personally guarantee the business account or your social security number is linked to the debt. The lender will likely report a defaulted business loan to both the business and consumer credit bureaus in these cases.

How Can Business Loans Affect Personal Credit?

A business loan can affect your personal credit score in a variety of different situations.

If your business doesn’t have an EIN and the loan is tied to your social security number, for example, you would be personally liable for any debts if your business fails and is unable to repay them. Failure to make timely payments would affect your personal credit score.

Another scenario in which business loans can affect personal credit scores is when the borrower signs a personal guarantee. With a signed personal guarantee, both your credit score and your business’s credit score may be affected by missing payments. A personal guarantee also puts your personal assets at risk.

Recommended: Can Personal Loans Be Used to Start a Business?

5 Ways to Protect Personal Finances From Business Debt

If you’d prefer to keep your personal credit score separate from any business debts, there are some actions you can take to help make that happen. Below are some options you may want to look into.

1. Select the Right Business Structure

How your business is structured affects how banks and lenders interact with you. For example, if you’re a sole proprietor, it’s your name that will appear on every debt owed by your business, and your business and personal credit will be one and the same. Thus any late payments and defaults you accrue can have a negative effect on your personal finances.

If you want to sever ties, you would need to become a Limited Liability Company (LLC), S-corporation, or C-corporation. Each setup comes with a unique set of tax burdens and benefits, so when choosing a business structure, it can be a good idea to consult with a tax professional or business organization lawyer.

2. Open a Business Bank Account

Establishing a separate bank account for your business bank is one of the most important steps you can take to keep your company’s finances separate from your own.

When looking for the right bank to open a business checking account, you’ll want to consider services you need now and might need in the future (such cash flow management tools or merchant services), as well as fees for business accounts (which can be different from fees for personal accounts). Also, check the documentation requirements for opening a business bank account.

3. Consider Getting a Business Credit Card

It can be hard to get a business credit card right out the gate, especially if your credit rating is not excellent or close to excellent.

However, you may be able to find a business credit card that does not routinely report activity to the consumer credit reporting agents. Keep in mind, though, that you need to make all payments on time. Most major small business cards will report if you default on the card.

Another option may be to get a secured business credit card. A secured card uses money that you yourself deposit as collateral. This refundable deposit protects the card issuer in case of default.

Like a regular credit card, you make payments on any amount you use each month. After your business has proven to be financially responsible, you can request to upgrade to an unsecured business credit card.

4. Understand How Defaults Are Resolved

How a default is handled will depend on how the loan was set up. If you personally guarantee the loan, your lender may collect any collateral you put up to secure the loan, meaning you could lose your car or house. Likewise, all missed payments will show up in your personal payment history, which can lower your credit score and make it harder for you to get a personal loan or credit card.

If you or your partners did not personally guarantee the loan, then the business itself may be sued and any business assets you used to secure the loan might be seized. You can also expect fees, interest, and penalties to accumulate, as well as your business’s credit score to take a hit.

5. Communicate With Your Lender

When applying for a business loan, it can be a good idea to ask the lender whether it will look at your personal credit report and score before approving you for the loan. If so, this means the lender will be doing a hard credit check on your financial history, which could temporarily lower your score by several points.

It can also be smart to review any documents and contracts that accompany the business loan. If any of them request a personal guarantee and require your signature instead of your business’s, then you know you will be held personally liable for the loan or line of credit.

You may be able to challenge the personal guarantee, but if you do, the lender may deny your loan request or increase your interest rate, meaning you’ll pay more for the same product.

Personal Finances Affecting Business Loans

There are three scenarios where your personal finances might impact your ability to get a small business loan:

1.   Your business is structured as a sole proprietorship or partnership.

2.   Your business has a limited credit history.

3.   Your business has a low credit score.

If any of the above are true, the following may impact your ability to get a loan or your loan terms:

Personal Credit Score

If your personal credit score is low, it can have a negative impact on your business loan. It may not prevent you from getting approved, but it could keep you from getting strong loan terms.

Personal Debt

Personal debt also has the potential to lower your prospects for being granted a business loan. If you have a lot of debt in your name, it may give lenders enough of a reason to charge you high interest rates, fearing you may one day default on payments.

Recommended: No Money Down Business Loans

The Takeaway

Whether a business loan affects your personal credit depends on a few factors, including the type of loan you’re applying for, how you’re obtaining the credit, and your business structure.

Applying for a business loan or credit card can lead to a small hit to your personal credit score because of the hard inquiry from the lender. If you personally guarantee a business loan, your personal credit can also be affected. Finally, if you run a sole proprietorship or partnership, your personal credit could be affected by a business loan if you put your name on the loan documents.

However, business debts don’t impact personal credit if the company and the owner are two separate legal entities and the loan isn’t connected to your name or social security number.

If you’re seeking financing for your business, SoFi can help. On SoFi’s marketplace, you can shop top providers today to access the capital you need. Find a personalized business financing option today in minutes.

With SoFi’s marketplace, it’s fast and easy to search for your small business financing options.

FAQ

Are business loans based on personal credit?

In some cases, yes. A business loan will likely be based on your personal credit if your company is structured as a sole proprietor or partnership, if your business’s credit history is thin, or if your business has a low credit score.

Can a business loan show up on my personal credit report?

Yes, a business loan can show up on your personal credit report if you personally guarantee the loan or if the lender reports it to credit agencies. This typically occurs in cases of sole proprietorships or small businesses where personal and business finances are closely linked.

Do small business lenders check personal credit?

In some cases, yes. Lenders will likely check your personal credit if your business doesn’t have an Employer Identification Number (EIN), meaning the loan will be in your name, or if your business is new or has a low credit score.

Can a business loan affect getting a mortgage?

If your name is attached to the business loan in any way, then yes, it can affect your ability to get a mortgage.

When applying for a mortgage, your lender will likely look at your debt-to-income ratio. Your business loan (and any other debt you already have) combined with a new mortgage could potentially push you past the threshold that lenders like to see.

If your business is a separate entity, then a business loan will not likely impact your ability to get a mortgage.

Can my LLC affect my personal credit?

Yes, your LLC can affect your personal credit if you personally guarantee loans or credit for the business. In such cases, defaults or late payments could be reported on your personal credit report. However, if the LLC borrows without a personal guarantee, your personal credit may remain unaffected.

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Photo credit: iStock/Rockaa

SoFi's marketplace is owned and operated by SoFi Lending Corp. See SoFi Lending Corp. licensing information below. Advertising Disclosures: SoFi receives compensation in the event you obtain a loan through SoFi’s marketplace. This affects whether a product or service is featured on this site and could affect the order of presentation. SoFi does not include all products and services in the market. All rates, terms, and conditions vary by provider.

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.

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.

Disclaimer: Many factors affect your credit scores and the interest rates you may receive. SoFi is not a Credit Repair Organization as defined under federal or state law, including the Credit Repair Organizations Act. SoFi does not provide “credit repair” services or advice or assistance regarding “rebuilding” or “improving” your credit record, credit history, or credit rating. For details, see the FTC’s website .

SOSMB-Q324-054

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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.

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).

Recommended: Business Cash Management: Tips for Managing Cash

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:

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:

Working Capital = Current Assets − Current Liabilities

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%.

Recommended: APR vs Interest Rate: What’s the Difference?

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 can help. On SoFi’s marketplace, you can shop top providers today to access the capital you need. Find a personalized business financing option today in minutes.

Get personalized small business financing quotes with SoFi's marketplace.

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.

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Photo credit: iStock/Charday Penn

SoFi's marketplace is owned and operated by SoFi Lending Corp. See SoFi Lending Corp. licensing information below. Advertising Disclosures: SoFi receives compensation in the event you obtain a loan through SoFi’s marketplace. This affects whether a product or service is featured on this site and could affect the order of presentation. SoFi does not include all products and services in the market. All rates, terms, and conditions vary by provider.

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.

Disclaimer: Many factors affect your credit scores and the interest rates you may receive. SoFi is not a Credit Repair Organization as defined under federal or state law, including the Credit Repair Organizations Act. SoFi does not provide “credit repair” services or advice or assistance regarding “rebuilding” or “improving” your credit record, credit history, or credit rating. For details, see the FTC’s website .

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A debt instrument is a contract that enables one party to loan funds to another party, who promises to repay the loan plus interest. Debt instruments are also referred to as fixed income assets because the lender receives a fixed amount of interest during the lifetime of the instrument.

Debt instruments come in many forms. Some are obvious, such as mortgages and different types of small business loans; while others are less so, such as rental leases, bonds, and treasuries. With some debt instruments, you are the borrower, such as when you take out a mortgage or open a credit card. In other cases, you are the lender, such as when you purchase a bond or treasury.

Here’s what you need to know about debt instruments, the different types of debt instruments, how these instruments work, and the pros and cons of debt financing.

What Is a Debt Instrument?

A debt instrument is a fixed income asset that legally binds a debtor to pay back any amount borrowed plus interest. Debt instruments can be issued by individuals, businesses, local and state governments, and the U.S. government.

Businesses often use debt instruments to raise capital to purchase additional assets (such as manufacturing equipment) or to raise working capital, while local governments may do so to fund the building of infrastructure (such as a new highway or a bridge). Debt instruments also give participants the option to transfer the ownership of debt obligation (or instrument) from one party to another.

Debt instruments can be short-term (repaid within a year) or long-term (paid over a year or more). Credit cards and treasury notes are examples of short-term debt instruments, while long-term business loans and mortgages fall into the category of long-term debt instruments.

Recommended: 10 Steps to Starting a Small Business

Debt Instruments vs Debt Securities

Debt instruments are broad financial tools representing a loan made by a lender to a borrower, including mortgages, business loans, and leases. They may or may not be tradable.

In contrast, debt securities are a specific subset of debt instruments that are tradable on financial markets, such as government and corporate bonds. Debt securities provide liquidity, allowing investors to buy or sell them before maturity.

The key difference is that all debt securities are debt instruments, but not all debt instruments are tradable securities, emphasizing market accessibility and liquidity for debt securities.

How Do Debt Instruments Work?

If you’ve ever taken out a loan or opened a credit card, you probably already understand the basics of how debt instruments work. Debt instrument contracts include detailed provisions on the deal, including collateral involved, the rate of interest, the schedule for interest payments, and the term of the loan (or timeframe to maturity).

While any type of vehicle classified as debt can be considered a debt instrument, the term is most often applied to debt capital raised by institutions, such as companies and governments. In this scenario, the investor is the lender: You issue money to a business, municipality, or the U.S. government. In exchange for capital, you are paid back the amount you loaned over time with interest. Examples of this type of debt instrument include U.S. treasuries, municipal bonds, and corporate bonds.

Recommended: Lease or Purchase Equipment

Types of Debt Instruments

Below is a breakdown of some of the most common debt instruments used by individuals, governments, and companies to raise capital.

US Treasuries

U.S. Treasury Securities (also called treasuries) are government debt instruments issued by the U.S. Department of the Treasury to finance government spending as an alternative to taxation. Treasury securities are backed by the full faith and credit of the U.S., meaning that the government promises to raise money by any legally available means to repay them.

U.S. treasuries tend to be more affordable than many other debt instruments. Investors can buy them in increments of $100 either through brokerage firms, banks, or the U.S. Treasury website. There are three types of treasuries: treasury bills, treasury notes, and treasury bonds. Each treasury comes with its own maturity option.

Municipal Bonds

Municipal bonds are offered by various U.S. government agencies (towns, cities, counties, or states) to fund current and future expenditures. Programs often funded by municipal bonds include the building of schools, roads, and bridges. Think of a municipal bond as a loan an investor makes to a local government.

There are two types of municipal bonds: general obligation bonds and revenue bonds. General obligation bonds are not paid back by any revenue resulting from the completion of the project. Instead, they are paid back to investors through property taxes or overall general funds.

Revenue bonds are paid back by the issuer through either sales, taxes, or some other type of revenue generated by the project.

Municipal bonds are attractive to many investors because they are tax-exempt bonds — meaning the investor doesn’t have to pay taxes on any interest received.

Recommended: How to Buy Bonds: A Guide for Beginners

Corporate Bonds

A corporate bond is a debt security that a corporation can use to raise money. Funding is typically available to anyone who is interested. As with other bonds, corporate bonds are essentially an IOU from the company to the investor. It differs from stock in that, instead of being paid dividends when the company is profitable, investors are always paid regardless of whether the company is doing well.

Typically, corporate bond investors are paid interest until the bond matures. When it matures, the entire principal is paid back. For example, a $1,000 corporate bond with an interest rate (or coupon rate) of 5% would bring an investor $50 every year until the bond matures. This means that, after 10 years, the investor would see a gross return of $500.

With secured bonds, the company puts up collateral (such as property or equipment) as security for the bond. If the company defaults, secured bond holders can foreclose on the collateral to reclaim their money. With an unsecured bond, a holder may or may not be able to fully reclaim their investment.

Alternative Structured Debt Security Products

There are many types of structured debt security products on the market, many of which are issued by financial institutions. A common occurrence is for these institutions to bundle assets together as a single debt security product. By doing this, they are able to raise capital for the financial institution while also segregating the bundled assets.

Recommended: What Are the Different Types of Debt?

Leases

A residential or commercial lease is a legally binding contract between an owner of a property and a tenant, where the tenant agrees to pay money for a set period of time in exchange for use of the rented property. A lease is a type of debt instrument because it secures a regular payment from the tenant, thus creating a secured long-term debt.

Mortgages

Mortgages are a type of debt instrument used to purchase a home, commercial property, or vacant land. The loan is secured by the property being purchased, which the lender can seize if the borrower defaults on the loan.

As with many other consumer loan products, mortgages are amortized, meaning the borrower makes a series of equal monthly payments that provides the lender with an interest payment (based on the unpaid principal balance as of the beginning of the month) and a principal payment that will cause the unpaid principal balance to decrease each month so that the principal balance will be zero at the time of the final payment.

Recommended: What Is a Financial Instrument?

Pros and Cons of Debt Instruments

Understanding the pros and cons of debt instruments helps borrowers make informed decisions about their financing options.

Pros

Debt instruments can be mutually beneficial in that both parties become better off as a result. If a company takes out a small business loan and invests those funds wisely, for example, it can increase its profitability. Ideally, the increase in profits exceeds the cost of the loan, a concept known as leveraging in business. Borrowing money also allows a company to raise capital without losing equity.

Debt instruments also benefit individuals and governments. Without mortgage debt, many people would never be able to buy a house; without student loans, many individuals would not be able to go to college. For governments, debt instruments allow them to build infrastructure for the public good.

On the lender’s or investor’s side, debt instruments can provide a regular and guaranteed source of income and are considered a safe investment, provided the loan is secured.

Cons

But there are downsides to debt instruments, as well. Loans often come with restrictions on how they can be used and, if you don’t have good credit, interest rates can be high. Borrowing money also involves risk. Most commercial institutions will require you to put up collateral in the form of a property asset. If you lose your income or your business hits hard times and you cannot repay your loan, the lender can reclaim its debt by liquidating whatever you proposed as security, which means you can lose a valuable asset.

On the lender’s or investor’s side, debt instruments also come with risk. Unless you purchase a secured bond, you may not receive your principal back as the investor. Also, during periods of high inflation, bonds can actually have a negative rate of return. And, if you invest in corporate bonds, there is always the possibility that the issuer will default on payment.

Pros of Debt Instruments	Cons of Debt Instruments
Allows companies to expedite their growth	If a borrower has poor credit, interest rates can be high
Allows companies to raise capital without diluting equity	Loans often come with restrictions on how they can be used
Enables individuals to buy a home or pay for college	Loans often require collateral, which can be lost if debtor defaults on loan
For lenders/investors, secured debt is a safe investment	Investors can lose money if bond value declines
For lenders/investors, debt instruments provide steady income	Bond investors can lose money during periods of high inflation

The Takeaway

A debt instrument is a way for an investor to get a return on their money by loaning to either an individual, business, municipality, or the U.S. government. If you have a credit card or mortgage, or you own any bonds or treasuries in your investment portfolio, debt instruments play a role in your life.

Small business owners can also take advantage of debt instruments. You might not be able to issue corporate bonds at this stage of the game, but you may be able to access an affordable small business loan.

If you’re seeking financing for your business, SoFi can help. On SoFi’s marketplace, you can shop top providers today to access the capital you need. Find a personalized business financing option today in minutes.

With SoFi’s marketplace, it’s fast and easy to search for your small business financing options.

FAQ

What are some examples of debt instruments?

Common examples of debt instruments include personal loans, business loans, mortgages, leases, bonds, treasuries, promissory notes, and debentures.

What is the difference between a debt instrument and an equity?

With a debt instrument, the investor does not own any portion of the company. With equity, the investor is buying a portion of the company.

What are the features of debt instruments?

Debt instruments have three characteristics: principal, coupon rate, and maturity. Principal refers to the amount that is borrowed. The coupon rate is the interest amount paid by the borrower to the lender. Maturity is the end date of the debt instrument. It refers to when the debt is completely paid off with interest.

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Photo credit: iStock/insta_photos

SoFi's marketplace is owned and operated by SoFi Lending Corp. See SoFi Lending Corp. licensing information below. Advertising Disclosures: SoFi receives compensation in the event you obtain a loan through SoFi’s marketplace. This affects whether a product or service is featured on this site and could affect the order of presentation. SoFi does not include all products and services in the market. All rates, terms, and conditions vary by provider.

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.

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.

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Spot Bitcoin ETPs are a type of investment vehicle that seeks to track the spot price of Bitcoin. ETPs, or exchange-traded products, are a broader basket of investments that include both exchange-traded funds (ETFs) and exchange-traded notes (ETNs), and are listed on an exchange, and can be purchased or sold much like a stock.

But what’s critical to know is that generally, ETFs are regulated by the Investment Company Act of 1940 (the “1940 Act”). While the most common type of ETPs are structured as ETFs, not all are, and spot Bitcoin ETPs are a specific type of ETP that are not registered under the 1940 Act. As such, these ETPs are not subjected to the 1940 Act’s rules, and investors holding shares of Bitcoin ETPs do not have the same protections as those that are regulated by the 1940 Act, which means these investments have relatively higher associated risks.

What Is a Bitcoin ETP?

As noted, Bitcoin ETPs are a type of exchange-traded fund or product that allow investors to gain exposure to Bitcoin without directly owning it. These seek to track the price of Bitcoin. That means when the price of Bitcoin in U.S. dollars goes up, a spot Bitcoin ETP, trading on the stock exchange should also see its share values go up, and vice versa.

But it’s critical to note that Bitcoin ETPs have a much narrower focus than most other exchange-traded products, which started out with the aim of giving investors broad exposure to the stock market. But, like all investments, they have various risks associated with them. In fact, it’s possible that an investor could lose the entirety of their investment.

An Introduction to Bitcoin ETPs

Bitcoin ETPs are exchange-traded products that, effectively, allow investors to gain exposure to the crypto markets as easily as they would buy or sell a stock, as discussed. Again, a Bitcoin ETP seeks to track the price or value of Bitcoin, and so the value of a Bitcoin ETP share is designed to rise or fall in relation to the change in value of the underlying cryptocurrency.

It also means that investors don’t necessarily need to directly own Bitcoin to gain exposure to the market in their portfolio — they can invest in a security, the ETP, that seeks to track it, instead. Note, too, that all ETPs have related fees and expenses, which vary.

💡 Quick Tip: How to manage potential risk factors in a self-directed investment account? Doing your research and employing strategies like dollar-cost averaging and diversification may help mitigate financial risk when trading stocks.

What Are Spot Bitcoin ETPs?

Spot Bitcoin ETPs are investment vehicles that trade at “spot” value. “Spot” value, in this case, refers to the price of the underlying asset at any given time. So, if a buyer and seller come together to make a trade, they would do so at the spot price. There are spot markets for all sorts of commodities.

Where Can Investors Buy Spot Bitcoin ETP Shares?

Investors can buy spot Bitcoin ETP shares via numerous exchanges and platforms. While previously, investors interested in Bitcoin or other cryptocurrencies would need to trade on platforms that supported cryptocurrencies, since Bitcoin ETPs are exchange-traded vehicles, investors are likely to find them available on many other platforms — that includes SoFi, which allows investors to buy spot Bitcoin ETP shares as well.

Are There Other Spot Crypto ETPs?

Spot Bitcoin ETPs seek to track the price of a fund’s Bitcoin holdings, and other spot crypto ETPs, if and when they are approved and hit exchanges, will do the same.

Spot Bitcoin ETPs were first approved for trading by regulators in early 2024. There are ETPs that seek to track Bitcoin-exposed or Bitcoin-adjacent companies, too, as well as Bitcoin futures. Spot Ethereum ETPs – or Ether ETPs, as they would actually track Ether (ETH), the Ethereum blockchain’s native cryptocurrency – could be similar vehicles to to spot Bitcoin ETPs, in that they would seek to track the price of Ether, and allow investors to gain exposure to Ether in their portfolios without owning it directly.

What Are Bitcoin Futures ETPs?

Bitcoin futures ETPs are another type of ETP that give investors exposure to the price movements of Bitcoin via futures contracts. Futures are a type of contract that dictates the terms of a trade at a future date, and typically have underlying assets such as precious metals or other commodities — including crypto.

Accordingly, Bitcoin futures ETPs are crypto futures ETPs that specifically seek to track Bitcoin futures contracts. Regulators approved Bitcoin futures contracts in 2021, but again, investors should know that they don’t seek to track the price or value of the underlying asset exactly — which differentiates them from spot Bitcoin ETPs.

💡 Quick Tip: Look for an online brokerage with low trading commissions as well as no account minimum. Higher fees can cut into investment returns over time.

Are There US-listed Spot Bitcoin ETPs?

There are U.S.-listed spot Bitcoin ETPs. When the Securities and Exchange Commission (SEC) first granted their approval in January 2024, it opened the door to several Bitcoin ETPs hitting the market. As a result, investors were able to start buying and selling them via the stock market.

The SEC’s approval led to new spot Bitcoin ETPs being listed on a few different exchanges. Here’s a list of the first 11 spot Bitcoin ETPs that gained approval from the SEC:

•   Grayscale Bitcoin Trust (GBTC)

•   Bitwise Bitcoin ETF (BITB)

•   Hashdex Bitcoin ETF (DEFI)

•   ARK 21Shares Bitcoin ETF (ARKB)

•   Invesco Galaxy Bitcoin ETF (BTCO)

•   VanEck Bitcoin Trust (HODL)

•   WisdomTree Bitcoin Fund (BTCW)

•   Fidelity Wise Origin Bitcoin Fund (FBTC)

•   Franklin Bitcoin ETF (EZBC)

•   iShares Bitcoin Trust (IBIT)

•   Valkyrie Bitcoin Fund (BRRR)

Note, too, that it’s anticipated that additional spot cryptocurrency ETPs will become available.

How Are Bitcoin ETPs Regulated?

Bitcoin ETPs are regulated by the SEC, which sets out guidance in terms of legality. Regulation in the crypto space is and has been murky — it’s been largely unregulated for the entirety of the crypto space’s existence. But the advent of crypto ETPs is likely to change that to some degree, as spot Bitcoin ETPs’ underlying asset is and can be Bitcoin itself, rather than Bitcoin derivatives.

Remember, too, that Bitcoin ETPs are not regulated under the Investment Company Act of 1940, as discussed. That differentiates them from most ETFs on the market.

That’s another important distinction investors should note: Spot and futures Bitcoin ETPs may be regulated under slightly different terms, as futures are derivatives. Investors should pay attention to the space and to any SEC guidance released regarding crypto regulation, as it may impact the value of their holdings in crypto ETPs, too.

Pros & Cons of Bitcoin ETPs

Like all investments, there are pros and cons of ETFs and ETPs — including Bitcoin ETPs.

Benefits of Bitcoin ETPs

Proponents of Bitcoin ETPs appreciate that they can give investors exposure to the complicated and volatile cryptocurrency market, without the need to personally hold actual crypto.

Convenience and Ease

Buying a spot Bitcoin ETP requires little tech know-how beyond knowing how to use a computer, open a brokerage account, and place a buy order.

ETPs provide a way for investors to indirectly add exposure to certain assets — like Bitcoin, in this case — to their portfolio. That may result in a return on investment, or a possible loss of principal. On the other hand, holding actual Bitcoin may require a somewhat advanced level of technical expertise.

Secure Storage Options

Some cryptocurrency exchanges might be trustworthy, but some users have also had a controversial history of being hacked, stolen from, or defrauded. Even reliable exchanges open investors up to risk.

Securely storing cryptocurrencies — for example, storing the private keys to a Bitcoin wallet — is most often done by using either a paper wallet that has the keys written in the form of a QR code and a long string of random characters, or by using an external piece of hardware called a hardware wallet.

Risks of Bitcoin ETPs

First and foremost, investors should be aware that it’s possible that they could lose the entirety of their investment when investing in Bitcoin ETPs. There are, of course, other risks to consider as well, including volatility, costs, and the unpredictable and still largely-unregulated nature of the crypto market.

Volatility

The volatility comes from the occasional wild swings experienced in the price of Bitcoin and Bitcoin futures against most other currencies. This could scare investors that have a lower risk tolerance, enticing them to panic and sell.

Fees

One of the risks that comes from holding an ETP of any kind involves its expense ratio. This number refers to the amount of money a fund’s management charges in exchange for providing the opportunity for investors to invest in their fund.

If a fund comes with an expense ratio of 2%, for example, the fund management would take $2 out of a $100 investment each year. This figure is usually calculated after profits have been factored in, cutting into investors’ gains. In other words, some Bitcoin ETPs could be relatively expensive for investors to hold, but it’ll depend on the specific fund.

There can be other various types of fees that may apply to an investment in ETPs as well. While the specific fees will vary from ETP to ETP, investors will likely encounter one or a combination of commissions, account maintenance fees, exchange fees, and wrap fees (a type of management fee). Again, investors will want to look at an ETP’s prospectus or related documents to get a better sense of the costs associated with a specific ETP.

Fraud and Market Manipulation

Regulators have cited fraud and market manipulation as reasons for why they were cautious about approving a spot market Bitcoin ETP. It’s unclear how the SEC’s approval of spot Bitcoin ETPs may affect fraud and market manipulation in the crypto space, but it’s something investors should be aware of.

The Takeaway

Spot Bitcoin ETPs were approved for trading by the SEC in early 2024, and as a result, it’s likely that many more crypto ETPs will also hit markets and exchanges in the future — though nothing is guaranteed. Investors may use them to gain exposure to the crypto markets. For investors curious about the cryptocurrency market but not yet ready to invest in crypto itself, a Bitcoin ETP may represent another option. It may be best to speak with a financial professional before investing, too.

If you’re ready to bring crypto into your portfolio, you can invest in a Bitcoin ETP with SoFi. Along with many other types of investments, SoFi’s platform offers investors access to the crypto space through spot Bitcoin ETPs.

Ready to invest in your goals? It’s easy to get started when you open an investment account with SoFi Invest. You can invest in stocks, exchange-traded funds (ETFs), mutual funds, alternative funds, and more. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).

For a limited time, opening and funding an Active Invest account gives you the opportunity to get up to $1,000 in the stock of your choice.

FAQ

What are the options for Bitcoin ETPs?

There are Bitcoin futures ETPs and spot Bitcoin ETPs listed in the U.S., which investors can buy. Given the SEC’s approval of Bitcoin ETPs for trading in early 2024, there may soon be additional spot crypto ETPs available to investors in the future.

Are there US-listed Bitcoin ETPs?

As of July 2024, there are U.S.-listed spot Bitcoin ETPs after the SEC approved an initial batch of them, and it’s likely there will be more in the subsequent months and years.

Where can Bitcoin ETP shares be purchased?

Crypto ETPs can be purchased and traded on the stock market, alongside other ETPs.

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Photo credit: iStock/JuSun

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SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
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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.

Exchange Traded Funds (ETFs): Investors should carefully consider the information contained in the prospectus, which contains the Fund’s investment objectives, risks, charges, expenses, and other relevant information. You may obtain a prospectus from the Fund company’s website or by email customer service at https://sofi.app.link/investchat. Please read the prospectus carefully prior to investing.
Shares of ETFs must be bought and sold at market price, which can vary significantly from the Fund’s net asset value (NAV). Investment returns are subject to market volatility and shares may be worth more or less their original value when redeemed. The diversification of an ETF will not protect against loss. An ETF may not achieve its stated investment objective. Rebalancing and other activities within the fund may be subject to tax consequences.
Fund Fees
If you invest in Exchange Traded Funds (ETFs) through SoFi Invest (either by buying them yourself or via investing in SoFi Invest’s automated investments, formerly SoFi Wealth), these funds will have their own management fees. These fees are not paid directly by you, but rather by the fund itself. these fees do reduce the fund’s returns. Check out each fund’s prospectus for details. SoFi Invest does not receive sales commissions, 12b-1 fees, or other fees from ETFs for investing such funds on behalf of advisory clients, though if SoFi Invest creates its own funds, it could earn management fees there.
SoFi Invest may waive all, or part of any of these fees, permanently or for a period of time, at its sole discretion for any reason. Fees are subject to change at any time. The current fee schedule will always be available in your Account Documents section of SoFi Invest.

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