For online sellers seeking working capital financing for their operations, the industry jargon and language utilized at all stages of the process may become confusing and discouraging.
Continue reading through this guide as we lay out everything you need to know about the main working capital financing terms so you can navigate the process with ease and secure the financing you need for your business.
Certain financing methods, like bank loans, finetrading, or lines of credit, will require the merchant to make a personal guarantee, or liability, for the debt. This means the individual—usually a company’s director—is making a promise that they will repay the debt if their business fails to do so.
If a company takes out a $50,000 bank loan and later goes out of business, the business owner will need to pay the bank back with their own personal assets, such as your investments or property, which may put you at risk of personal bankruptcy.
Many lenders require a personal guarantee because it minimizes the level of risk they face and ensures they will be paid back even if the customer’s business fails.
On a similar note, lenders may require business owners to put up collateral in order to receive funding. Collateral is an asset that the business uses to secure financing and is commonly real estate, inventory, or equipment.
There are two sides to this. For one, lenders may request the business owner to put up collateral to lessen the risk of the deal. In the case the business fails and is unable to make payments, the lender can repossess the asset as repayment instead.
On the other hand, secured debt is often available at lower interest rates since it’s less risky, which benefits the borrower both personally and financially.
In some cases, lenders may provide business financing based on the future cash flow projections of a company.
Cash flow is a measure of how much cash the business generates during a certain period due to operating activities, investment activities, and financing activities. Read here how to optimize your cash flow cycle to run smoother financial operations.
When a lending institution makes cash flow-based financing decisions, they are essentially purchasing the future cash flows of the company.
Another important term to keep in mind while discussing working capital financing is interest. By definition, interest is the cost of borrowing–it’s the monetary fee paid for the convenience of borrowing capital. It is often denoted as a percentage rate, so the total interest a borrower pays will correlate to the amount of financing they secure.
The actual interest rate charged by lenders will vary based on the type of debt or loan provided and may fluctuate with the overall market and monetary policy.
Interest payments are already included in the repayment schedule provided by the lender, though it’s still an important figure for business owners to consider.
If a business borrows $20,000 at a 6% annual interest rate, it will pay $1,200 per year for interest. On the other hand, if they were able to secure the loan at a 4% interest rate, they will only pay $800 per year in interest. So, you can see the implications of having a higher interest rate, and why borrowers prefer a lower rate.
Lastly, fee models is a common term you may come across when shopping around for working capital financing. In addition to the interest that a lender will charge to borrowers, they also may impose additional fees to be paid.
Some examples of fees include one-off charges like application or origination fees. However, there may be recurring fees like annual or maintenance fees that will be charged to borrowers on a regular basis for the lifetime of the loan.
Fees may be charged as a fixed price, or they may be based on a percentage of the financing secured. In either case, fees add another cost that businesses need to consider when they’re comparing working capital financing options.
Are you paying your company a fee or an interest? 1% may not always mean the same depending on the lender's pricing model—make sure you know which one is applicable in your case.
After considering the terms described above, you hopefully have a better grasp on the common jargon related to working capital financing and how these concepts impact borrowers.
While securing working capital financing is a crucial part of doing business in the earlier stages, many e-commerce businesses may not have the collateral or cash flow history that many traditional lenders require to make a loan. Plus, making a personal guarantee may seem too risky for online sellers.
However, there is a solution for merchants to secure financing and act on growth opportunities without all the complications of working with traditional lenders: asset-based financing.
Online sellers like asset-based financing for the flexibility with repayment it provides, in addition to the favorable documentation and business history requirements. Plus, they don’t lose control of their e-commerce store, unlike other financing methods.
When working with an asset-based finance provider like Myos, online sellers share the risk and avoid making a personal guarantee or putting up their own collateral. Instead, Myos makes its lending decisions based on the products the business sells, assessing how it will perform in the marketplace and using the AI prognosis of its future results.
Now that you learnt about the basics of working capital terms, check out asset-based financing with Myos and how it can benefit your small business.