Working capital loan or line of credit?

A business can be profitable on paper and still run short of cash while customers take 60 days to pay. The owner then hears two familiar suggestions: get a line of credit, or get a working capital loan. They solve different timing problems. An operating line usually bridges receivables and inventory that turn back into cash soon. A working capital term loan can spread the cost of a growth project whose return takes longer to arrive. Choosing between them starts with the cash cycle, not an advertised rate.

The difference in one table

The labels are not standardized across every institution. BDC gives typical comparisons, including a line linked to receivables and inventory and a working capital loan with a multi-year amortization; BDC itself says it does not offer operating lines. Ask each lender how its own product works rather than assuming all loans carrying the same name have identical terms.¹

Start with the cash conversion cycle

Suppose a distributor pays for inventory on day 15, delivers it on day 35 and receives customer payment on day 95. The business must fund stock, freight and wages while it waits. The gap is not automatically a sign of weak sales. It can be the result of a strong order book combined with payment terms. But it will recur every time the company buys and sells, so a fixed term loan that never turns over may be the wrong tool for the revolving portion of the need.

Write the timeline before talking to a lender: when must suppliers be paid, when does stock arrive, when is delivery accepted, when can the invoice be issued, and when does the customer actually pay? A forecast based only on a stated 30-day term can underestimate the gap if actual collections take 55 days. Model both the typical and a delayed case. Identify the highest draw, the lowest cash balance and the month in which the line should repay.

An operating line may bridge this gap if the lender accepts the receivables and inventory. If part of the cash need comes from a permanent warehouse expansion or new software, separate that investment and test a term loan. Otherwise, the line could remain fully drawn after the original invoices are paid, which defeats the logic of a revolving facility.

How an operating line really works

A business line of credit has an approved ceiling, but the amount available today may be lower. Many lenders calculate availability using eligible receivables and eligible inventory, then deduct reserves or senior claims. BDC explains that older, intercompany or other ineligible invoices can be excluded and that inventory categories receive different treatment under the agreement.² Ask for the definition of eligibility in writing.

Consider a $500,000 approved line with $350,000 in current invoices and $180,000 in inventory. If the lender's illustrative rules count 75% of invoices and 40% of inventory, then deduct a $25,000 reserve, the base is $309,500: $262,500 + $72,000 - $25,000. If $240,000 is already drawn, the remaining availability under this simplified example is $69,500, despite the $500,000 headline limit. The actual agreement may impose more exclusions, reserves or a maximum limit. These percentages are example inputs, not market-standard advances.

Borrowing capacity can contract when a customer pays late, inventory ages or an invoice becomes disputed. On the other hand, a well-managed business that turns inventory quickly and collects reliably can make the line more useful. A monthly forecast should include both the expected balance and a stress case. BDC notes that operating lines are generally demand facilities and commonly renewed annually, which introduces a different risk from a scheduled term loan.¹

When a working capital loan is a better fit

A working capital term loan can finance spending whose payoff extends beyond a short invoice cycle. BDC lists growth projects such as product development, new market entry, training and hiring, and notes that the decision usually relies more on company cash flow than a specific tangible asset.¹ A term schedule is useful when the owner wants a known payment path rather than a borrowing base that rises and falls each month.

Suppose a 40-person industrial services firm needs $600,000 over the next year to hire a technical sales team, earn certifications and enter a new province. Those costs do not immediately create invoices eligible for an operating line. A lender may instead assess how much incremental gross margin the expansion can generate, when contracts are expected and whether existing cash flow can carry payments even if the plan takes longer. The forecast should show the ramp month by month. A strong base case without a delayed case is incomplete.

Working capital loans can still require a personal or corporate guarantee and financial covenants even when no specific asset is pledged. They are not free of risk. BDC observes that lines often have lower rates because receivables and inventory secure them; the right decision also depends on flexibility, reporting and total cost.¹ For equipment or commercial real estate, examine an asset-specific facility whose term can match the asset's life.

When the answer is both facilities

A manufacturer can need a $400,000 operating line for normal inventory and collections plus a $500,000 term loan to implement a new production process. The line should revolve as stock becomes receivables and then cash. The term loan should be repaid from the expected gain in cash generation over several years. One lender may offer both, or separate institutions may participate. If there are two lenders, security ranking and intercreditor terms matter. The company should map its existing charges before promising the same receivables or equipment twice.

There is also a middle case. A temporary gap that grows during an expansion could have a revolving component and a longer-lived component. Split the request based on a 13-week cash forecast and an annual forecast. A lender can then see which dollars repay through collections and which repay through sustained earnings. ALOS's guide to funding an awarded contract illustrates this split, while the broader nine financing options article compares other structures.

Compare total cost and control, not a single rate

Ask how interest is charged: on outstanding daily draws, on the full loan balance or under another method. Add commitment, setup, renewal, appraisal, legal and unused-line fees where applicable. Compare the rate benchmark, spread, minimum balance, repayment flexibility, collateral and guarantees. On a line, calculate average and peak draws. On a term loan, calculate scheduled payments and total interest over the expected holding period.

A simple illustration shows why timing matters. A $300,000 line drawn for 90 days at a hypothetical 10% annual simple rate incurs about $7,397 of interest ($300,000 × 10% × 90/365), before fees and changes in balance. Leaving the same $300,000 drawn all year would cost about $30,000 at the same rate. The line is useful when the draw truly retires after customer cash arrives. This is arithmetic, not a quoted lender rate.

For a term loan, a smaller monthly payment can be attractive during a growth ramp even if the nominal rate is higher. Test whether the project produces enough incremental cash to cover it, then review covenant headroom in a weak month. The lowest interest number is not necessarily the best fit if it forces the business to keep a fragile line near its limit.

What to give a lender

1. A one-page purpose. State the amount, use of funds, why the cash is needed now and exactly how repayment will occur.
2. 13-week cash forecast. Show daily or weekly inflows and outflows around the peak need, with a customer delay scenario.
3. Receivables aging and inventory detail. Separate current, overdue, disputed and related-party invoices; show turnover and obsolete stock.
4. Financial statements and debt schedule. Include existing facility limits, balances, rates, maturity dates, covenants and collateral.
5. Project forecast if asking for a term loan. Connect hiring or market expansion costs to realistic timing of new revenue and margin.
6. Two written term sheets. Compare a line, a term loan or a combination on identical cash-flow assumptions.

Present the financing need before choosing a product label. A lender may see a better solution after it understands the business. If a facility has been declined, our seven reasons business loans are declined guide helps identify which evidence to improve. If the quoted rate or security requirement looks high, use our better financing terms checklist.

Measure the gap before increasing debt

Working capital on a balance sheet is current assets minus current liabilities. It is a useful starting point, but it is not the amount of cash available for payroll tomorrow. A warehouse can hold substantial inventory that will take months to sell, and a receivable may be current on the balance sheet while a customer is consistently late. Calculate how long stock sits, how many days customers take to pay, and how quickly suppliers require payment. The difference drives the funding cycle.

A small change in collection speed can have a large effect. If annual credit sales are $6 million, an additional 15 days of average collection time represents roughly $247,000 of sales tied up in receivables ($6 million ÷ 365 × 15), assuming a steady sales pace. This is a diagnostic approximation, not cash automatically recoverable. Some invoices will be ineligible for financing. Before requesting a larger line, the owner can investigate invoice disputes, billing delays and customer concentration. Financing helps bridge a sound cycle; operational improvements may reduce the gap at its source.

Ask whether the apparent gap is seasonal, growing with revenue or permanently embedded in the business. A seasonal company may draw deeply for three months and repay after sales. A company expanding every quarter may require a larger permanent working-capital base. A loss-making company with a line that never reduces needs an operating plan as well as a financing conversation. Different causes warrant different products. For the statement-level view of how profit and cash diverge, read profitable but running out of cash.

Questions to ask each lender

Request the actual eligibility rules for receivables and inventory, the frequency of reporting, how customer concentration is treated and whether the line is payable on demand. Ask what happens if availability falls below the drawn amount. For a term loan, ask how much of the project budget can be advanced, when payments begin, whether principal deferral is possible, and what reporting or guarantee accompanies the facility. Ask both lenders how they would view a slower sales case and whether the company could preserve an existing operating line.

There is no universal rate comparison that decides the issue. A line's rate may be lower but a long-lasting draw can accumulate substantial interest; a term loan may cost more per dollar but protect the line for daily operations. The application should show when each dollar enters the business, what it funds and the event that creates repayment cash. That is the clearest way to compare proposals without treating two unlike products as interchangeable.

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