Working capital finance and business loans are often treated as the same thing. Both provide funding, and a business loan can be used for working capital. The difference that matters is what the money is for and how long you need it.
Working capital finance supports the day-to-day operating cycle of a business. A business loan is often used for a specific investment that pays back over time. Matching the type of funding to the purpose helps you avoid paying for money you do not need, or running short when you do.
Two different jobs for money
Funding the operating cycle. Most businesses spend money before they receive it. They buy stock or materials, pay staff and suppliers, then wait for customers to pay. That cycle repeats continuously. The cash tied up in it is working capital, and the amount needed often rises and falls with activity. See what is working capital for a fuller explanation.
Funding a specific investment. Some spending is a one-off commitment designed to produce a return over a longer period. Refurbishing premises, opening a new location or developing a new service are typical examples. The money goes out once, and the benefit comes back gradually.
Working capital finance is designed for the first job. It is often flexible or revolving, so you can draw what you need, repay as cash comes in and draw again. Forms include revolving credit facilities, overdrafts, invoice finance and trade or stock finance. A business loan is usually better suited to the second job, with a fixed amount repaid over an agreed term.
Matching the funding term to the purpose
A useful principle is to match how long the funding lasts to how long the need lasts.
- Short-term or recurring needs usually sit better with flexible facilities that can be drawn and repaid as the cycle turns.
- Longer-term investments usually sit better with term funding, where repayments are spread over a period that reflects when the benefit arrives.
When the two are mismatched, problems can follow:
- Using a short-term or revolving facility for a long-term project can absorb headroom you need for daily trading. It can also leave you needing to refinance before the investment has paid back.
- Taking a long-term loan to cover a temporary gap can mean paying for money you no longer need once the gap closes, with repayments continuing after the pressure has passed.
Equipment and vehicles are often a third case. Asset finance can spread the cost of an asset over its working life, with the asset itself typically forming part of the security.
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Examples of each
Typical working capital needs include:
- buying extra stock ahead of a busy season
- paying staff and suppliers before a large order is invoiced and paid
- covering the gap created by long customer payment terms
- paying a supplier earlier in exchange for better terms
- absorbing a temporary dip in receipts
Typical uses of a business loan include:
- refurbishing or fitting out premises
- opening a new site or entering a new market
- investing in a new system or a longer-term marketing programme
- funding a defined expansion plan with a clear budget
Some needs sit in between. Recruiting a team to service a growing contract has elements of both: the salaries recur, but the growth they support may take time to produce cash. In cases like this, a combination of facilities is sometimes used. For more on planning this kind of spending, see how to fund business growth.
Questions to ask before choosing
Working through a few questions can clarify the requirement before you approach any provider:
- Will the need repeat as part of normal trading, or is it a one-off?
- Will the cash come back through the trading cycle, or from the longer-term benefit of the investment?
- How long is the spending likely to take to pay for itself?
- Does the need rise and fall with sales, or is it a fixed sum?
- What facilities and security are already in place?
A commercial finance intermediary such as Emirex Finance can help you think through the answers and the types of funding that may fit. The finance provider makes the final lending decision.
Key points
- Working capital finance funds the recurring operating cycle. A business loan often funds a specific investment.
- Matching the funding term to the purpose helps avoid tying up headroom or paying for funds you no longer need.
- Flexible, revolving facilities usually suit needs that rise and fall with trading.
- Fixed-term loans usually suit one-off spending that pays back over a longer period.
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This guide is general information, not financial, legal or tax advice. Finance is subject to status, eligibility and approval by the relevant finance provider. Emirex Finance works with UK limited companies only and is not authorised or regulated by the FCA.