Working capital
Working capital or term loan: which one does your business actually need?
Choosing the wrong structure is more expensive than choosing the wrong rate — and it is a far more common mistake.
The distinction that matters
A term loan gives you a fixed amount repaid in fixed instalments over a fixed period, and suits a one-time requirement such as equipment, expansion or a defined project. A working capital facility gives you a limit you draw on, repay and draw again, with interest usually charged only on what you use, and suits a recurring gap between paying suppliers and being paid by customers.
Put simply: a term loan funds something you buy once. A working capital limit funds the cycle you run every month.
Diagnose the problem first
Before choosing a product, work out what is actually short.
| Symptom | Likely diagnosis | Structure that fits |
|---|---|---|
| Cash is tight in the same weeks every month | A timing gap in the operating cycle | Overdraft or cash credit limit |
| Cash is tight only when a large order comes in | Growth consuming working capital | A limit sized to the peak, not the average |
| Money is stuck in invoices on large, reliable buyers | A receivables gap | Invoice or bill discounting |
| A specific asset needs buying | A capital requirement | Term loan, or asset-linked finance |
| Cash is tight every month regardless of sales | A margin or cost problem | Not a financing problem — pricing, cost or mix has to change |
That last row is the important one. Borrowing to cover a structural shortfall adds an EMI to a business that already cannot cover its costs. The loan arrives once; the shortfall arrives monthly.
The working capital options
- Overdraft. A limit on your current account you can draw beyond your balance, with interest on usage. Suits irregular, unpredictable gaps.
- Cash credit. A limit assessed against stock and receivables, with drawing power reviewed periodically against a stock statement. Suits inventory-carrying trading and manufacturing businesses.
- Working capital demand loan. A short fixed-tenure loan for a defined operating need. Suits a known amount for a known period.
- Invoice or bill discounting. Funding against confirmed invoices, repaid when the buyer pays. Usually the cheapest way to release receivables where buyers are strong.
- Supplier credit. Negotiated payment terms from your own suppliers — frequently the cheapest working capital available, and the most overlooked.
Why a limit can quietly become a term loan
A revolving facility is meant to fluctuate: drawn when the cycle demands it, cleared when collections arrive. When a limit sits permanently at its ceiling and never comes down, it has stopped funding a cycle and started funding a permanent hole — with no repayment schedule and no end date.
Lenders watch for this at renewal, and it affects both continuation and enhancement. More importantly, it is a signal worth heeding for your own sake: a limit that never reduces is telling you something about the business that a profit and loss statement may not be.
Sizing the limit
Measure the operating cycle
How many days money spends in stock, plus days in debtors, minus days of supplier credit. That number, applied to your cost base, is roughly what the business needs funded.
Size to the peak, not the average
A limit set on average requirements will be inadequate exactly when it is needed.
Leave room for growth
If sales are growing, the working capital requirement grows with them. Sizing to today's turnover means renegotiating in six months.
Check the cost of unused limits
Some facilities carry charges on unutilised portions. Ask, and factor it in.
Plan how the limit gets cleared
A facility with no plan for periodic clearance will drift towards a permanent drawing.
The better question
Before financing a gap, it is worth asking whether the gap can be narrowed. Invoicing on the day of delivery, following up on a schedule rather than from memory, negotiating supplier terms deliberately, and stopping reorders of slow-moving stock all shorten the cycle — permanently, and at no interest cost. See cash flow planning for business owners.
More detail on working capital facilities and unsecured term loans.