Key takeaways

  • Be sure to understand all aspects of your loan agreement, including the loan amount, APR, repayment term, loan cost and fees
  • Budgeting, paying bills on time, and keeping debt to a minimum is key to managing a working capital loan
  • Talking to your lender before missing a payment can help you prevent default

A working capital loan can give you a way to weather the storm or jump on a business opportunity. But if you’re considering a short-term business loan, line of credit or any other option to bridge a cash flow gap for your business, you need to make sure it makes sense in the big picture. Yes, this loan might help you today. But how will it impact your financial future?

Answering that question comes down to managing the loan well. So before you start shopping for working capital loans for small businesses, take a moment to make sure you know what to do with that money once you get it — and before you need to repay it.

What happens if you don’t pay a working capital loan?

Working capital loans for small businesses help some businesses thrive, but they tank others. That’s because the ramifications are quite serious if you don’t repay what you borrow.

One missed payment will likely land you with fees and cause a dip in your credit score. But if you continually miss payments and your lender’s grace period expires, you enter default.

At this point, the lender can accelerate loan repayment, which means you owe the full sum of whatever they lent you. If you can’t repay it (a very likely outcome), you put anything you used to secure the loan at risk. While you can get an unsecured working capital loan — often in the form of a line of credit or a high-cost option like a merchant cash advance — the best loan rates come from secured financing. That means you put up business collateral, made a personal guarantee or both.

If you put up business collateral, you might have offered up company equipment, real estate or other high-value assets to back the loan. If you made a personal guarantee, your personal assets are on the line, too. And the lender can seize anything you used to secure the loan to compensate for any loss when you default.

Plus, if you default, it will tank your credit score and seriously limit your financing options moving forward.

To help you avoid all of that, here are a few steps to best manage your working capital loan.

Bankrate insight

Working capital loans have higher rates and fees and shorter repayment periods than other types of loans. These factors can often make repayments unmanageable. If you have time to plan ahead, a low-interest business loan will help you save money.

Understand your loan agreement

Do this before signing for a short-term business loan or any other working capital loan. Your loan agreement won’t be light reading, but you must fully understand it, from your repayment term to all associated loan fees. Once you sign, the agreement is legally binding.

Here are some key aspects of your loan agreement to wrap your head around:

Loan amount This is the amount of money you’re getting from the lender, usually minus certain fees and costs.
APR The annual percentage rate (APR) is the total loan cost — including interest and fees — per year.
Repayment term This explains the time you have to repay and when repayments are due. With a working capital loan, this could be often (daily, weekly).
Loan cost and fees Lenders charge money to originate loans, meaning you’ll likely need to pay some upfront costs and fees. The loan agreement should explain them.
Collateral Unless you’re getting an unsecured working capital loan, this is what you put up to back the loan — and what the lender can seize if you default.
Prepayment penalty Some working capital loans come with fees if you pay back what you borrowed ahead of schedule.
Penalty fees These fees arise because you missed a payment. They can be steep, so make sure you understand the ramifications.
Event of default This tells you what has to occur to technically reach default (such as missing payment for 90 days) and what happens in that event.
Acceleration This possible loan feature allows the lender to accelerate your repayment faster than the loan term, usually because you missed payment.

Have a budget

Once you understand your potential loan agreement, you need to make sure it fits into your overall business budget.

Your budget tells you how much money your business spends, where it spends it, how much cash runway you have and more. Every business should have a budget, but this gets especially important if you take out a loan.

At the very least, your business budget should look at current and projected revenue, fixed costs (payroll, leasing costs, subscriptions, insurance, taxes, etc.) and variable costs (marketing, utilities, etc.). You need to make sure the total of your fixed and variable costs in any given period is less than the revenue in that period, especially if you plan to add a working capital loan into the mix.

Generally, lenders want to see two years of financial reporting for a company before issuing a loan, which is a good rule to use for yourself. Looking back over your business’s revenue and spending over the last two years can help you build a business budget you can trust. Then, you can use that to forecast revenue and spending for your working capital loan term. Make sure that when you factor in those loan payments, everything still comes up positive.

If you’re struggling to organize your finances, we have a few tips to help.

Pay your bills on-time

Paying on time means a boost to your credit score, plus it helps you avoid unnecessary costs like late fees and penalties.

This doesn’t just apply to working capital loans for small businesses. You need to pay on time to your utility providers, vendors and anyone else your company owes.

For help, ask if any of your bill issuers offer autopay (most working capital loan lenders will). This way, they can make an automatic draw from your business bank account so you don’t have to worry about writing a check or logging into your account to pay. Then, the trick is to ensure you always have sufficient funds in that linked account.

Keep debt to a minimum

Working capital loans for small businesses can be a huge help or a potential pitfall. Because these loans may require faster repayments, it’s easy to fall into a debt trap. To keep up with the payments for your loan, you might be tempted to take out another loan or put it on your business credit card. But this way, debt builds up — and so does the interest your company has to cough up.

While managing a working capital loan, avoid other debt unless necessary. Focus on paying back what you’ve already borrowed.

Check your credit

You might think your credit score only matters when you’re trying to get a loan, but it can be a huge help as you manage your loan. If you have high personal and business credit scores, you’ll be better positioned to negotiate with your lender if you ever have trouble making payments.

Periodically check your business and personal credit scores. As you pay back your working capital loan, those should go up. Also, make it a point to get a credit report at least annually and go through it line by line. If you find an error, dispute it. This can also give you a credit score bump.

Talk to your lender

If you ever think you might be in a position to miss a payment, talk to your lender before that payment date. While lenders are more than happy to collect late fees for one missed payment, they don’t want you to go into default. Collections or legal proceedings cost them money and effort, and they would rather avoid that outcome.

As a result, your lender might offer an option like:

  • Short-term repayment modifications, like interest-only payments for a period of time
  • A loan term extension
  • Short-term deferment or forbearance
  • A loan settlement amount

Your lender is more likely to agree to an adjustment if you have a good reason for making the request (like a seasonal ebb, a personal emergency) and a good credit score. In any case, it’s always worth contacting your lender to explore your options.

Bottom line

The best working capital loans can be the boon your business needs — but only if you manage them well. Before you sign for a loan, make sure you’ve explored all of your short-term financing options, and you clearly understand the one you plan to use.

Then, once you get the loan proceeds, stay diligent about managing them and your company’s overall finances. As you repay your working capital loan, your credit score should grow.

Frequently asked questions about how to manage a working capital loan

  • It all depends on how you manage it. Because these loans are generally easier to get, they can greatly help businesses needing cash infusion. But if you don’t manage the loan and repay what you borrow in the agreed-upon timeline, it can risk your credit score and business and personal assets.
  • Businesses might consider a working capital loan to weather a seasonal downturn, invest in needed equipment, bring on headcount or otherwise bump up cash flow. But you should only get a working capital loan if you’re confident your business can pay back what you borrow on a quick repayment schedule.
  • That depends on your lender. Online lenders might offer as little as $10,000, while an SBA working capital loan can go up to $5 million. Generally, lenders will issue working capital loans for small businesses with proceeds of around 20 percent of the business’s annual revenue.