What is a Working Capital Loan?
A working capital loan is a loan used by companies to cover day-to-day operational expenses.
How Does a Working Capital Loan Work?
In many cases, companies are unable to generate the revenue needed to meet expenses incurred by day-to-day business operations. In such circumstances, companies may apply for a working capital loan. Unlike most other business loans that allow companies to acquire capital in order to expand, a working capital loan covers only expenses incurred by existing capital and human resources (e.g. utilities, rents, payroll, etc.). Working capital loans are generally granted only to companies with a high credit rating, and are only meant to be used until a company can generate enough revenue to cover its own expenses.
For example, suppose company XYZ's current capital and human resources incur $1000 in monthly expenses from daily operations. Company XYZ's monthly revenue, however, is only $700. In order to meet monthly expenses, company XYZ takes out a working capital loan for $300 until its monthly revenue reaches the $1000 required.
Why Does a Working Capital Loan Matter?
A working capital loan allows companies to continue their daily operations despite an inability to cover ongoing operating expenses. In this way, companies can “buy time” to find ways of generating the necessary revenues based on their existing capital and human resources.