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What is a working capital loan?

A working capital loan funds the day-to-day costs of running a business, such as stock, wages, rent and tax bills. It is short term and is repaid from the cash the business takes in. It is not used to buy long-lived assets like buildings or machines. Lenders size it against how long cash is tied up.

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How lenders use it

A lender first asks what the money is for. A seasonal stock build, a gap while customers pay late and a one-off bill are all valid uses. A loss that keeps repeating is not a working capital need. It is a sign of a deeper problem.

The credit team then works out how much cash the business needs. It looks at how many days stock sits, how long customers take to pay and how long the business takes to pay suppliers. It reads the bank statements for seasonal peaks and dips and the management accounts for current trading.

The loan term should match how long the need lasts. A seasonal need fits a short loan or a revolving facility. Using a long loan for a short need costs more. Using a short loan for a lasting need risks a default.

The lender also looks at other debt, the debtor and creditor lists and the debt service coverage ratio. A business that is late with tax or suppliers raises concern. Some lenders ask for security. Others lend on cash flow or against invoices.

Worked example

Example only. A distributor has yearly cost of sales of £1,095,000, which is £3,000 a day. Stock sits 50 days, customers pay in 40 days and the business pays suppliers in 30 days.

Cash is tied up for 50 plus 40 minus 30, which is 60 days. At £3,000 a day, the business needs about £180,000 of working capital. A lender might offer a facility near that figure, then check that cash flow can repay it.

Common confusions

Working capital in the accounts is current assets minus current liabilities. A working capital loan is a product. The accounting figure helps size the need, but the two are not the same thing.

A working capital loan is not a single product. It can be a term loan, an overdraft, a revolving credit facility, invoice finance or a merchant cash advance. Lenders use the label for the purpose, not the structure.

A US SBA 7(a) loan can be used for working capital. It is a government-backed loan with its own rules. That is a different product from a plain bank loan.

Questions lenders ask

How do lenders assess a working capital loan?

They check the purpose, the size of the cash gap, recent bank statements, current management accounts, debtor and creditor lists, existing debt and the debt service coverage ratio. They also look at whether the need is seasonal or ongoing.

What can a working capital loan be used for?

Stock, wages, rent, supplier bills, tax payments and marketing. It is not meant for buying property or machines. Those need longer finance that matches the life of the asset.

How long is a working capital loan?

Usually from a few months up to two years. A revolving facility can stay in place longer, with a yearly review. The term should match the length of the need.

What is the difference between a working capital loan and an overdraft?

A loan pays out a fixed sum and is repaid on a schedule. An overdraft is a limit on the bank account that the business can draw and repay as needed. Bank overdrafts in the UK are usually repayable on demand.

This page is general information for lenders. It is not legal, tax or credit advice.

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