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Whether your company is a startup or a small business looking to get to that next level, there are a variety of funding options available to consider. — Getty Images/PeopleImages

When it comes to getting a loan for your small business, asking the wrong questions — or none at all — can be a costly mistake. Small businesses have lots of borrowing questions on everything from how to apply for a small business loan to the different types of small business loans available. Here are the most common small business loan questions — and their answers.

What is working capital?

In the simplest terms, working capital is the difference between a business’s assets (cash and anything that can quickly be turned into cash) and its liabilities. Working capital is potential energy for a business, providing the liquidity necessary for rapid response in a changing business climate. Sufficient working capital, therefore, is essential for business success.

How does a company increase working capital?

Working capital is determined by a mathematical equation: short term assets – short term liabilities. Adjusting the ratio means changing the numbers on one or both sides. A company can increase its working capital by:

  • Attacking overhead and reducing expenses (rent, utilities, salaries), so the business can slow the flow of money out, thus increasing cash on hand.
  • Increasing profit margins, making more capital available to run a business. Raising prices or lowering inventory cost — by purchasing in bulk, for example — will both have a positive impact on cash flow.
  • Taking advantage of prompt payment vendor discounts will increase capital.
  • Converting short-term debt to the long term will free up cash, as will renegotiating more advantageous terms on both.
  • Selling long term assets.

What is a business working capital loan?

Working capital loans are short-term instruments used to cover a temporary cash (working capital) shortage. As such they are generally repaid within one year, with the borrower making frequent payments. Unlike some other forms of funding, working capital loans do not transfer to an equity stake in a business. And, while they are used to run a business from day to day, working capital loans are not used to purchase equipment.

[Read our full story on working capital loans.]

Who provides working capital loans to small businesses?

Working capital loans are given to small businesses from four different lenders:

  • Banks provide working capital through overdraft arrangements, lines of credit and short-term loans.
  • Credit card companies are another source of working capital, through a Merchant Cash Advance (MCA), paid directly from credit card receipts. The daily repayment is automatically deducted from the borrower’s bank account.
  • Factoring firms, through an arrangement known as factoring, provide funds to small businesses in exchange for ownership of its accounts receivable. The factoring firms buy a company’s outstanding receivables for cash and takes responsibility for their collection. When the funds are collected a small percentage may be returned to the business.
  • Online lenders, depending on varying factors like a company’s credit score, business volume and years in business. Interest rates and repayment terms vary as well.

[Read our full story on factoring.]

What is a small business cash flow loan?

Cash flow loans are those extended to a business based on the anticipated flow of money into its coffers. To qualify, a business will need to demonstrate that revenue is — or will be — coming in.

Cash flow loans address short-term liquidity issues and as such are paid back quickly, with frequent payments. As money comes into the business, some of it is paid out to the lender, as often as daily. Because cash flow loans are made on the expectation of revenue flowing in rather than on assets a company holds, they are typically unsecured.

What are short-term loans?

A short-term loan is a description that can apply to many borrowing arrangements. Any advance of funds that has a quick repayment time — typically less than one year — with a pre-determined repayment schedule, can be labeled a short-term loan. Since a company needs to remain solvent long enough to repay any loan, the shorter the term, the less risk a lender is taking and the easier it is to qualify.

What are the sources of short-term loans for business?

The two main sources of short-term lenders are:

  • Banks, which are usually the best place to start if a business has a good relationship with its bank.
  • Online and alternative lenders. When taking this route, years in business, credit score and business volume will all impact the range and cost of loan packages.

What are the advantages and disadvantages of short-term loans?

Advantages of short-term loans include:

  • A quick approval process — less than a day with some online lenders — and less paperwork. If a business is in a time crunch, this accelerated turnaround time can be a big advantage.
  • Less total interest paid, because they are set up for quick repayment.
  • Easier qualification, even for businesses lacking an excellent credit history, because the shorter time frame limits the lender’s risk.

Disadvantages of short-term loans include:

  • The higher interest rate and, in some cases, origination fees lenders charge to compensate for the risk and administrative costs.
  • Larger payment amounts, because the total borrowed is broken up into fewer payments.
  • Some short-term loans have a large pre-payment penalty.

While business loans are, by definition, financing, all financing is not in the form of a loan.

Which is cheaper, short-term or long-term loans?

Given an equal amount borrowed, a short-term loan, with its higher interest and larger payments, is more costly on a day-to-day basis, which can add to an already strained cash flow equation. However, when the overall cost is calculated, a short-term loan is often less expensive because less total interest is paid.

How do I get a loan for my startup?

Startup loans are available from many of the same lenders that provide capital for going concerns. Rather than basing a loan on cash receipts or business history, startup loans are based on ideas and plans and the business owner’s personal credit record.

As with short-term loans, the two main options for startup loans are banks and online lenders. With either option, however, the business owner should have a good personal credit history and a well-developed business plan.

Personal investors, like coworkers, community members and family members are also possible sources of seed money for startups with a compelling story to share.

[Read our full story about starting a business.]

What’s the difference between a business loan and financing?

While business loans are, by definition, financing, all financing is not in the form of a loan. Grants are a form of funding that does not need to be repaid. Funds received in exchange for an equity stake in the business or raised through crowdfunding in exchange for free product are also types of financing that are not loans.

What is a business line of credit?

A business line of credit is a predetermined amount of money a business has access to when needed. It is not a loan until funds are spent and interest is paid only on the amount borrowed. Because the paperwork is done in advance, lines of credit offer great flexibility for a business to borrow exactly what is needed, when it is needed.

Banks offer business lines of credit to established concerns. While larger lines may be secured by collateral, most are unsecured. Banks will be looking for an established credit history.

Lines of credit are also available through online lenders. The amounts and terms they offer vary and depend on years in business, business volume and credit history.

[Read our full story on business lines of credit.]

Is interest from a small business loan deductible?

While an accounting professional should be consulted, the general answer is yes, legitimate interest paid is a cost of doing business and, as such, is deductible if:

  • The funds were borrowed from a legitimate creditor. The interest paid on casual loans from friends or relatives is not deductible, as the IRS has no way of confirming the legitimacy of the agreement.
  • You are legally required to repay the loan.
  • The money was actually spent. Interest paid on funds that were borrowed and deposited in a bank account does not qualify as a business tax deduction.

How do I get an SBA loan?

While the Small Business Administration doesn’t lend money, it facilitates the borrowing of it by partnering with those who do. By backing a portion of the loan, the Small Business Administration (SBA) can mitigate the risk, making it easier for businesses to qualify.

Through its online referral tool Lender Match, the SBA can quickly connect borrowers with SBA approved lenders.

Does my business qualify for an SBA loan?

Not every business qualifies for an SBA-backed loan. Requirements include:

  • The business must be small. To determine if your business qualifies as a small business, use the SBA Size Standards Tool.
  • The business must be for-profit.
  • The business must be physically located in the United States.
  • The business owner must have skin in the game in the form of equity, time or both.
  • The business must have exhausted other funding options.

CO— aims to bring you inspiration from leading respected experts. However, before making any business decision, you should consult a professional who can advise you based on your individual situation.

Published October 09, 2019