Your guide to working capital loans

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When you start a small business, you’re probably not thinking too carefully about the cash conversion cycle. Yes, you think about who you need to pay and who will pay you, but the precise terms and timing are secondary. 

Which leads to an all-too-common occurrence: SMBs with bills coming due long before they have cash in the bank. This in turn stymies new investments and makes it hard to grow.

Thankfully, working capital loans exist for exactly this reason. And unlike their consumer cousins “payday loans,” they don’t need to be a solution of last resort. 

Many successful, smart SMBs regularly tap into short-term loans to finance growth. Here, we’ll examine how and why they do just that. 

What is a working capital loan? 

A working capital loan is a line of credit used to fund your company’s day-to-day operations. Working capital is essentially the cash flow you need to run your business. Without access to sufficient working capital, you risk failing to pay suppliers on time or running short of inventory. In the right circumstances, a loan gives you the cash you need to avoid these issues. 

A working capital line of credit is best used in the very short term, to finance a specific campaign, initiative, or to meet unusually high customer demand. To act quickly in cases like these, short-term financing in the form of a loan is ideal. 

When might you need a working capital line of credit?

Like most financing, a loan may be necessary where you have a clear need for funds, but don’t have those funds on hand. For small businesses, this can be a one-off or regular occurrence, even built into your business model. 

Here are some of the most obvious examples.

Seasonal spikes in demand

Increased demand is usually a good thing, except if you can’t service it. For e-commerce, retail, hospitality, and plenty of similar industries, you need to order (and often pay for) physical inventory before you can sell it. If you don’t have cash set aside, or can’t order goods on credit, you’ll struggle to meet that new wave of demand. 

The same is often true for services businesses. Clients often pay on delivery of the service, which can be 60 or 90 days after you start — or more. In the meantime, you need to pay staff, hire freelancers or consultants, book venues and equipment, and lots more. 

In both examples, the best thing for the business is to take advantage of the increased demand. And a short-term loan gives you the available cash you need. 

Slow periods

The flip sides of seasonal spikes are the down times. That could be an annual feature (or bug) of your industry, or a blip caused by supply chain issues and environmental issues. Some you can plan for and create a rainy day fund. Others hit without warning. 

During these times, you still need to keep the lights on. People need to get paid, stock still needs to be ordered, and you still need to do business. 

Short-term financing can keep your working capital in order until the sunnier days arrive. 

A hot growth opportunity

From time to time, an event or circumstance outside your control gives you a rare opening to take a step up as a business.

An obvious example for European companies will be the Olympics in Paris in 2024. Virtually every industry — but especially retail, hospitality, and entertainment — can expect a sudden spike in demand. 

A more common example is advertising. Whether it’s television, radio, print, or online, ad spot prices can vary considerably. And occasionally there’s the rare opportunity to take a placement that either hasn’t sold or the original buyer backed out — at a very hefty discount. 

Opportunistic companies should jump at these chances. And a working capital loan is an extra source of cash to ensure you don’t miss out.

Supply chain issues

Supply chains can be complex for many businesses, and complexity often leads to cash flow challenges. For example, suppose you have multiple product lines, and you use the cash from Product A to produce and sell Product B. If you have supply issues with product A, you don’t have the cash to invest in Product B.

Assuming the issue is temporary — perhaps another boat got stuck in the Panama Canal — there isn’t anything to solve in the long term. So a simple loan to keep selling Product B is a great help. 

Asymmetrical cash cycles

There are also companies using short-term financing on a procedural basis, and not only in response to an urgent need. You may need to pay suppliers at a faster cadence than you get paid by customers. That’s just the nature of the business model. 

In this case, a regular line of credit that you can dip into dynamically makes a lot of sense. This can help you turn a 15-day supplier payment term into 30 days, to line up with what you offer your own buyers. 

How real businesses use working capital loans

To help illustrate how working capital issues can play out — and how working capital loans can help — we have four key examples. 

1. Allocab

Allocab is a private chauffeur and moto-taxi service with a classic cash conversion challenge. 2C Finance Senior Manager Hugues Chabalier helps Allocab’s finance function. As he explains, “we need to pay drivers much sooner than we can collect payments from our B2B clients, who we bill on standard payment terms.”

So it makes sense to plug the gap with short-term financing. 

“‍We also use factoring. But it doesn’t address our issue of paying on our service providers (drivers) well before invoicing our clients. It often only works for our larger invoices, not all of them. And the service isn't always suitable, especially for clients with complex approval processes.”

Hugues and the Allocab team need to be able to tap into funding quickly, without renegotiating terms every time. Which is why they use Defacto. 

“We get a maximum line of credit to use for payment campaigns, which is then regenerated by customer collections. And this credit line automatically evolves with our usage and growth, already increasing by 30% since our launch.” 

“This flexibility is a significant advantage over traditional bank lines.”

2. Akolads

Akolads operates in a totally different industry from Allocab, but has remarkably similar challenges. A boutique SEO and SEA agency, you might expect that overheads are low and that there are relatively few challenges to pay suppliers. 

But the issue again comes from long customer payment terms. Like many agencies, Akolads is often paid 45 or 60 days after delivering services. But as founder Emmanuel Bismuth explains, “we have to pay our suppliers within 30 days, and our employees at the end of the month. This complicates our cash flow management and our working capital requirements increase every year.” 

A growing company simply can’t risk not paying staff or face penalties from suppliers. It also can’t go into credit card debt or take burdensome loans on a regular basis. 

“Having an available cash flow line is a key factor for success. Without Defacto, I would be forced to refuse clients and greatly reduce my growth. Because growth needs to be financed. 

“My company doesn’t go into debt because I only request financing for invoices awaiting payment.”

3. Terramica

Terramica distributes organic Italian products directly from the producers. “Olive oil is our flagship product,” says co-founder Camille Frachon, “but we offer the full range of Italian products, from Venetian salads to mascarpone, fresh gnocchi, or pesto.”

Sourcing these products often requires payment up front. Artisan suppliers can’t or won’t deliver goods on credit. So Terramica needs the cash to fill its inventory long before it can recoup the costs.  

“Access to short-term financing is essential to ensure our business runs smoothly and sustainably.‍” Which is where Defacto can help. 

And the way that these working capital loans take shape is key. “The ability to make early repayments and flexibility in the duration of financing are major assets. They allow us to effectively manage our cash flow and optimise our daily operations.”

In practice, this means a thriving, energetic business. 

“The biggest opportunity lies in the ability to explore new collaboration opportunities with our producers. With this financial support, we can continue to develop our product range while maintaining our commitment to quality and authenticity.”

4. Selency

Selency is Europe’s top online marketplace for preloved furniture and home decoration. Already famous among consumers, the company is working hard to increase its B2B offering. 

These buyers have longer payment terms, similar to the Allocabs example above. So Selency needs ways to extend payment terms with its own suppliers, or it may hit working capital issues. 

According to Head of Finance Xavier Serre, new projects can cost €25,000 to manage. “Thanks to Defacto, we can easily respond to demand without holding back.”

Short-term working capital loans keep the company in a strong financial position. “We gained 15 days of working capital requirement by extending our supplier payment terms while maintaining good business relationships.”

And unlike more traditional funding sources, Defacto perfectly suits a modern, growing business. “We appreciate the transparency regarding fees, which lets us better anticipate and manage our financial costs. The integration of Defacto into Pennylane was smooth and straightforward, providing an effective alternative to traditional banking processes.” 

“The impact of Defacto on our financial performance and our team's efficiency has been significant.”

Get working capital financing that works for your business

Business loans and working capital financing are nothing new. But as any founder familiar with factoring knows, these funding sources can be administratively complex and time consuming to access. Which is the last thing you need when time is of the essence. 

Whether you have urgent needs, a hot growth opportunity, or just asymmetry in your cash flows, working capital loans may be just what you need. And the more flexible and transparent, the better. 

This is exactly what we provide at Defacto: fast, flexible, and fair financing for small businesses. It only takes 27 seconds to get started, and you can use your line of credit as and when you need it — without getting on the phone or visiting an office. 

See how it works today. 

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