Working capital loan or term loan: which fits?
Two ways to pay for day-to-day costs and one-time projects, and why a merchant cash advance is a different thing again.
Updated First published Published by BizLoan.now
"Working capital" describes what the money is for: payroll, inventory, rent and the gap between paying suppliers and getting paid. A "term loan" describes how the money is repaid. So the real question is which product fits the job. For most owners it comes down to three choices: a term loan, a line of credit, or a working-capital advance.
The three options
Term loan. You get a lump sum and repay it in fixed payments, usually monthly, over a set term. It suits one-time costs with a clear payoff: an expansion, a renovation, equipment, or replacing more expensive debt. See small business term loans.
Line of credit. You get a limit, draw what you need and pay interest only on what you've drawn. Repaying frees the limit up again. It suits uneven cash flow and seasonal inventory. See business lines of credit.
Working-capital advance (merchant cash advance). A provider pays you a lump sum in exchange for a share of your future sales, usually collected by daily or weekly debits. Most advances are structured as a purchase of future sales, not a loan. They're fast and often easier to get, but they usually cost far more. See working-capital advances.
Side by side
| Compare | Term loan | Line of credit | Working-capital advance |
|---|---|---|---|
| What you get | A lump sum | A limit you draw from | A lump sum |
| How it's repaid | Fixed payments, usually monthly | Payments on what you've drawn | Daily or weekly debits, or a share of sales |
| How cost is stated | Interest rate and APR | Interest rate on what you draw, plus fees | A factor rate, not an interest rate |
| Time to funds | Often 1 to 4 weeks | Often 1 to 2 weeks | Often a few days |
| Usually costs | Least of the three | Moderate | Most of the three |
How to work out a loan payment
For a fixed-rate loan, the monthly payment is:
Payment = P × r ÷ (1 − (1 + r) ^ −n)
where P is the amount borrowed, r is the monthly rate (the annual rate divided by 12) and n is the number of monthly payments.
As an illustration only, assume $50,000 at a 12% annual rate. That's an assumption to show the math, not a typical or offered rate.
| Term | Monthly payment | Total repaid | Total interest |
|---|---|---|---|
| 24 months | $2,353.67 | $56,488.17 | $6,488.17 |
| 60 months | $1,112.22 | $66,733.34 | $16,733.34 |
A longer term lowers the payment and raises the total cost. The payment calculator runs this for your own numbers.
How an advance is priced
An advance uses a factor rate. A factor rate of 1.40 on a $50,000 advance means you repay $70,000. If that's collected over about seven months of business-day debits, it's roughly 147 payments of $476.19.
The factor rate isn't an interest rate. Converted to an estimated APR, that example is above 100%, and paying it back faster makes the APR higher, not lower. Fees withheld from the amount you receive raise it further. The factor rate to APR calculator does the conversion.
Which fits
- A one-time cost you can repay over a year or more: a term loan.
- Ongoing, uneven needs like seasonal inventory: a line of credit.
- A short gap with a clear, quick return, when a loan or line isn't available: an advance may work, but compare the total payback with every other option first, and ask for the written cost disclosure some states require.
Many businesses use a term loan for a project and a line of credit for day-to-day cash flow at the same time.