Working Capital Financing: How does it compare to a traditional bank funding, what are the advantages, and disadvantages, and how is repayment calculated?
When John took over his family’s small sporting goods store and manufacturer, he knew he had big shoes to fill. His parents had built the business from the ground up, making it a pillar within the community. As John settled into his new role, he quickly realized that he needed a cash injection to expand online, and to buy raw materials and inventory. John’s company struggled to keep with inventory and pay bills on time. That is when John heard about working capital financing and started researching it online.
John reached out to Zip Capital Group and was pleasantly surprised by how easy the application process was. He was approved in an hour and received the funds he needed to get his business back on track the next day. John was able to repay the advance through a percentage of his cash flows, which meant he only paid back the financing when the cash was available.
With the advance, John was able to set up an e-commerce website, buy raw materials, and restock his inventory. Within a month, business picked up, and John was able to remake the payments with ease.
This story, or something like it plays out in several homes and businesses each day across the United States. In this article, we will:
- Define working capital financing
- How it differs from a bank funding,
- Discuss its advantages, and disadvantages, and
- Learn about factoring
What is working capital financing?
Working capital financing is a type of financing that allows an applicant to receive a lump sum of cash in exchange for a percentage of the applicant’s future credit card sales. The business owner, or borrower repays the advance by providing a percentage of their daily cash flows to the lender until the advance is repaid in full. This type of financing can be a good option for businesses that have high cash flows, but may have bad credit, or problems qualifying for a traditional funding.
How is it different from traditional funding?
Working capital financing is different from other forms of small business funding in several ways:
- Qualification: It tends to have less strict qualification criteria compared to traditional funding, making them more accessible to businesses that may not qualify for a bank funding.
- Speed: Working capital financing can be approved and funded quickly, while traditional funding can take weeks or even months to be approved and funded.
- Risk: It is higher risk than traditional funding.
- Repayment: It is typically repaid through a percentage of incoming cash flows, while traditional funding have fixed monthly payments.
- Costs: It has higher costs than traditional funding because of the additional risk undertaken by the lender.
- Collateral: It does not require collateral, while traditional funding may require the business to put up assets such as real estate or equipment as collateral.
What are the advantages of working capital financing?
There are several benefits to working capital funding, including:
- Quick and easy access to funds. Working capital funding can be approved, and funded quickly, which can be helpful for business with pressing financial needs. At Zip Capital Group, approvals are driven by the cash flow of the business. Additionally, we typically provide a funding decision the same day, with funding the next.
- No collateral required: Working capital funding doesn’t require collateral, so businesses that do not have valuable assets to put up as collateral can still access funding.
- Flexible payment terms: The repayment terms of working capital financing are based on the cash flows of the business, so the business owner only pays back the advance when they have the cash available. They also have a choice as to the frequency of repayment. Zip Capital Group offers daily, weekly, and other repayment options.
- Easy to qualify: Working capital funding providers tend to be more lenient in their lending standards than traditional lenders, which can make it easier for a business to qualify.
- No fixed payments: Working capital funding does not have fixed payments, the repayment is a percentage of cash flows, which can be beneficial for businesses with fluctuating sales.
- No long-term commitment: Once a business has fully repaid working capital financing, there is no long-term commitment or ongoing obligation.
What are the disadvantages of using a working capital financing?
- Short repayment period: It may have a shorter repayment period than traditional funding.
- Impact on cash flow: Paying back working capital funding may impact a business’s cash flow. As a result, a borrower should plan for it.
What is a factor rate?
A factor rate is used in working capital financing to determine the total cost of financing. The factor rate is the percentage that is applied to the amount of the advance to calculate the total amount that the business will need to repay. The factor rate is typically higher than the annual percentage rate (APR) used for traditional funding, as a result, this type of financing tends to be higher risk and come at a higher cost.
To illustrate, assume a business receives working capital financing of $10,000 with a factor rate of 1.3, the business would need to repay a total of $13,000 ($10,000 x 1.3) to repay the financing.
Since working capital financing is not a funding, it does not have an interest rate, but instead, it represents the total cost of financing including the interest and any other fees.
To compare the cost of working capital financing with other forms of funding, it is important to look at the factor rate, which can be found on the contract, and use it to calculate the total cost of financing.
Concluding thoughts about Working Capital Financing
If you are a business with a large borrowing capacity, access to credit, and are not in need of capital, there are many funding options available to you. In contrast, if you have limited credit, good cash flows, and need funding quickly, this financing may be an option for you.
In this article, we provided a definition for working capital financing, compared it to a traditional bank funding, discussed their advantages and disadvantages, and learned about repayment.
Zip Capital Group has been providing merchant cash advances, equipment financing, and working capital funding to businesses of all sizes for years. We have a team of Small Business Funding Specialists waiting to hear from. you. Contact us or call today at (800) 795-3919 to learn if working capital financing is right for your business.
