Introduction
An unexpected change in your business’s financial situation can be incredibly stressful. This is when working capital loans may help cover the shortfall.
It’s typical for businesses, both large and small, who want to use borrowed capital to meet their day-to-day needs.
Working capital finance, also known as a short-term loan, helps businesses to increase working capital in a business. This type of finance is ideal for business owners who find themselves in a financial crunch and need an extra boost to cash flow.
Working capital money can be used to finance a company’s everyday operations such as stock, payroll or taxes such as VAT. It is, however, not to be used to finance long-term assets such as equipment, or investments such as property. It ranges from short-term loans and bank overdrafts to invoice factoring and debtor finance.
Funding amounts for this type of financing can range from R50 000 to R5 million with a relatively quick vetting and approval process.
Main Features
Application process
It’s never been easier for small business owners to apply for finance. Many lenders allow for business owners to apply online to qualify for a business loan in South Africa. The entire process is digital so they can approve your application directly on the platform if you provide the relevant and correct documents.
Collateral
This is an asset that an applicant uses in order to qualify for a secured loan. In the case of a borrower defaulting on the agreement in a secured loan scenario, the lender has the ability to take possession of these assets. As a cash advance is an unsecured product, it does not require collateral. This is a win for new businesses that don’t yet have a lot of assets.
Interest rate
The interest rate, which is expressed as a percentage (%), is owed on an amount lent over a fixed term. As part of the loan agreement, business owners will be required to pay back the principal amount, along with the agreed interest.
There are a number of factors that can affect the interest rate you get on your business loan, including, your credit score and whether it’s secured or unsecured. While the interest rate is set by the South African Reserve Bank’s Monetary Policy Committee, it is possible for business owners to negotiate the interest rate they get.
Repayment term
This term refers to the amount of time it takes to pay back the total amount borrowed from a funding provider. This term may be set and known as a ‘fixed term loan’. Alternatively it may be flexible, which allows funds to be paid back in line with the business’ turnover and therefore uses an estimated repayment period.
Secured/ Unsecured
Working capital finance can either be secured or unsecured. With secured loans the borrower is required to put up assets as security or collateral. This is to ensure that the business does not skip any repayments. An example of security is paid-up property. A disadvantage of this type of business loan is that it often has a longer approval time because documents have to be checked prior to approval.
The unsecured loan option does not require the borrower to put up any collateral as security, however the borrower is required to sign personal surety for the loan amount. One disadvantage of an unsecured loan is the higher interest rate, making it more expensive than a secured option. Typically only companies or business owners with a high credit rating are eligible for an unsecured loan. A major benefit of this type of loan is quick approval and payout.
Qualifying criteria
It’s important for business owners to be clear on what is required of them before they apply for funding.
With regards to working capital funding some of the requirements a business needs to meet are:
- Registered and operational for 12 months
- Have a good credit standing
- Meet a turnover threshold
- Six months bank statements
- For a secured loan some of the documents a lender may request any of the following: annual financials, management accounts, bank statements, debtors listing and title deeds.
Pricing
Principal loan amount – The full loan amount the borrower is required to repay.
Interest rates – In addition to the principal amount the borrower is required to pay interests on the loan amount. A loan that is considered low risk by the lender will typically have a lower interest rate. The amount of interest you must pay will depend on the business loan terms, which will be agreed on in advance with the lender.
Additional fees – Closing fees or other transaction costs fees that you need to pay before, during and after the loan process.
Credit score – When applying for a business loan, lenders will assess the risk of lending you money. To lenders, bad credit scores mean there is a high risk of the loan not being paid back. Your credit score will make it harder to get funding, or result in a more expensive loan with a higher interest rate.
Buyer's Guide
Application process
The process of applying for working capital finance is similar to many other funding options.
For greater convenience and transparency, most funders allow borrowers to complete an online application where they can select their loan amount and choose their terms (6 or 12 months). Online applications have made it possible to get approval within 24 hours, however this differs for each funder.
Business needs
Before applying for a loan business owners should be clear that they are securing the correct financial product for their business. It’s also important to understand the terms and conditions of each financial product, whether it makes financial sense to take on additional financing, and lastly, understand the financial impact on their cash flow to service such a facility.
Other considerations business owners should be aware of is not to take on additional debt to fund operating expenditure such as salaries or rental, unless it’s to cover a cash flow shortfall. It is also not recommended to service existing third party facilities that are in arrears.
Compliance
Compliance is an important consideration for businesses that are looking for external financing. It’s important that your business adhere to all its tax and legal requirements.
Some of the business documents you may be required to submit include: company registration documents; office lease or mortgage agreement; shareholder agreements; share register; proof of business address; relevant business licences; accreditations or registrations.
Financial records that lenders may want to see are your latest annual financial statements, latest VAT statement; last three/six months’ bank statements, tax clearance certificate.
Return on investment
The money you borrow for your business should benefit your business in the long and short term. Business owners need to ensure the return on investment (ROI) on their additional financing offsets the cost of funding to maximise profitability.
It is therefore important for business owners to consider financing solutions that meet their business needs in terms of cost, terms and conditions and avoid any hidden costs that may arise at a later date, including early repayment penalties etc.
Benefits of working capital
- Keeps your business afloat when cash flow is slow
- Quick application and approval process
- Fund growth or big projects
- Cover emergency expenses
- Sustain your business during slow times – payroll, equipment upgrades, inventory Marketing expenses
