Working Capital Loan Definition

Working Capital Loan Definition

Sometimes firms do not have enough liquidated assets to run the day-to-day activities. These business operations include rent, debt payments, and payroll or wages and salaries. Liquid assets are assets that can be easily converted into cash without losing its original value. During times like this, they seek for working capital loans.


This article will focus on working capital loan definition and all you need to know about working capital loan.

Before we go further on working capital loan, there are some important terms we need to define so as to have a good basic understanding of working capital loan. The terms to understand are:
Working capital
Loan

We will commence by defining working capital.

What is working capital?

Working capital can be defined as the difference between the current assets and current liabilities of a company. It is a financial metric, which determines whether a company has enough liquid assets to settle its financial obligations that will be due within a year. Working capital is the money used to settle the day-to-day operations of a business. Let us briefly explain the meaning of current assets and current liabilities;

Current Assets: They are short-terms assets that will become cash by the end of the fiscal year (e.g, inventory or accounts receivable).

Current Liabilities: These are debts owed by a business to outsiders that must be paid in the next twelve months. Examples are short-term loans and accounts payable.

The formula below will be used to determine your business’s working capital:

Working Capital = Current Assets – Current Liabilities

Let us solve a question that involves finding the working capital of a business. For example, say the current assets and current liabilities of your business look something like this:

CURRENT ASSETS
Cash: $2,000
Inventory: $5,000
Accounts Receivable: $3,000
Total: $10,000

CURRENT LIABILITIES
Tax Payable: $4,000
Accounts Payable: $3,000
Credit Card: $1,000
Total: $8,000

From the example above, $10,000 – $8,000 = $2,000, therefore your business would have $2,000 worth of working capital. The $200 will be used to run the daily activities of your business.

The next term to understand is loan. The meaning of loan will be explained below.


What is Loan?

A loan can be defined as the money that one or more individuals or companies lend from banks or other money lending financial institutions to enable them financially manage planned or unplanned events in the business. By taking a loan, the borrower incurs a debt, which he/she has to repay with additional interest and within a specified period of time. A loan is recorded as a liability in the balance sheet.

Since we now have the basic definition of working capital and loan, it is time to know the definition of working capital loan.

What is working capital loan?

In the simplest definition, working capital loan is the debt the company uses for its daily operations. The loan can be either secured or unsecured.

Working capital loans are not used to start up a business or for buying business assets, they are intended to give you the cash flow required to handle the expenses of running your business. This means that when you want to start up a business and need financing, you don't need working capital loans because working capital loans are designed to provide cash flow for an existing business.

These loans are very important to the business because they can provide the much-needed cash at critical times. With working capital loans, you'll be able to organize your operations, keep your business going, and look for important expansion opportunities for your business.

How Much Working Capital Does Your Business Need?

As you’re contemplating on taking a working capital loan, I believe you’re also probably asking yourself: how much working capital does my business need?

However, you want enough working capital that will cover your business expenses and pay your debts, but you also want to use your assets to further invest in your business.


Reasons To Get A Working Capital Loan

It Depends on your business and industry, there can be several different reasons to get a working capital loan. In this segment, we will be looking at some of the most common reasons why businesses get a working capital loan.

1. Inconsistent Cash Flow

If your customers take a long time to pay for goods purchased or your inventory takes a long time to turn over, the cash flow of your business will suffer greatly. When cash flow is inconsistent, it can make it difficult to settle bills on time and run your business. A working capital loan grants you access to cash when needed.

2. Seasonal Sales Fluctuations

Working capital loans will be of great importance to seasonal businesses that need to pay business expenses during off-season when sales are slow.

Seasonal businesses can also use working capital loans to buy inventory before a holiday rush to prepare for increased sales.

3. Business Growth Spurts

It’s not a thing of surprise that startups and young businesses can have difficulties making ends meet and financing the daily operations of the business. Working capital loans help new businesses to settle everyday expenses, pay their employees, hire new ones when necessary.

4. New Business Opportunities

Nothing is worse in business than letting go of a huge business opportunity because you don’t have the funds to pursue it. A working capital loan can assist you to purchase new equipment, invest in training, or give you the resources you need to expand your business and take advantage of opportunities as they come.

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