Avoid the Pitfalls of Short Term Working Capital

Originally published
Originally published: 11/1/2019

It’s vital to know your options and plan for the future to obtain financing that will not constrict the cash flow of your business.


The service contracting industry is flush with great resources for critical components of your business, including as flat rate pricing, marketing and software. And rightly so, these components are important to a successful business. Equally as important is a business’s ability to properly secure the right working capital loan when the need for capital arises. But step cautiously, as securing the wrong working capital loan can be like putting the proverbial final nail in your company’s coffin.

Short Term Working Capital Loans

For some time, short term, high interest rate lenders have been around, but with many taking advantage of the Internet, their accessibility to businesses has increased substantially. These non-bank lenders are not bound by the same rules and regulations of a traditional bank. Their mode of operation is to be able to offer to small businesses working capital loans very quickly with minimal hassle.

The quick process and lack of upfront hassle are attractive attributes to business owners who are in a cash crisis, unfortunately the terms of these loans often put in place payment terms that adversely affect the cash flow of the business. It is vital to know your options and plan for the future to obtain financing that will not constrict the cash flow of your business.

As a borrower, it is critical that you pay attention to the terms of the loan as it has been proven over and over again that the shorter the terms, the more challenging it is for a borrower to keep up with payments (pay-back).

In addition, the unforgiving short pay-back periods, non-bank lenders are free to charge you high interest rates. Understand what you are agreeing to before borrowing as unrealistically high interest rates coupled with a short pay-back period is recipe for disaster. Let’s look at an example.

Assume John runs an HVACR business and produces $1M in annual sales and after a reasonable salary paid to John, the Company earns $100,000 (cashflows from operations).

Despite current profits, John is seeking additional capital to make upgrades to his office as well as purchase additional equipment. John estimates that he needs $150,000 for the office upgrades and equipment purchases.

John goes to a non-bank short term lender and with very little paperwork or delay, secures a $175,000 loan, of which $150,000 is used immediately for office upgrades and equipment purchase and $25,000 is retained for working capital reserves. The loan is a short term 12-month loan. Because John does not expect to have the loan for more than a year, he is able to justify the 15.0 percent annual interest the lender expects him to pay.

Keep in mind, the interest rate associated with these short-term loans can be well above 15.0 percent. To secure the loan John signs a personal guarantee and the lender will most likely place a lien on the operating entity, both of which are common terms associated with any small business loan.

A $150,000 loan with a 12-month term and 15.0 percent interest will call for 12 payments of $15,795 each. Let’s assume John’s business is not seasonal (although we know in actuality all HVACR businesses have their seasons).

With this assumption John’s business earns $8,333 a month ($100,000/12). You can see there is already a problem, the monthly payment of $15,795 exceeds the monthly earnings. But the end is not immediate here is how it plays out (see Chart 1 below).

The first three months provides John some cushion. The retained working capital of $25,000 plus the $8,333 a month in earnings offers some relief (and for once a positive bank account). But there is trouble ahead, the $15,795 a month in loan pay-back pulls hard on John’s cash and by the end of Month 4, the cash account is negative. By the end of the 12 months, all things remaining constant, John is short $64,544.

The most alarming point to this example is the Company is profitable through all this! The reality, no small business can sustain an aggressive pay-back period like what John has agreed to. If cash reserves aren’t sufficient, the business doesn’t increase its profitability, many businesses will resort to adding on more short-term debt or increasing credit card usage, which can ultimately layer on too much debt and put the business in a real bind.

SBA Lending Options

One solution is to consider is a short-term working capital loan from an SBA lender such as Live Oak Bank ( Live Oak Bank specializes in SBA lending and by doing so, is able to efficiently lead the process of securing financing for small businesses. Although securing SBA financing may involve a few extra steps (as opposed to other non-bank sources) the end result will be a short-term working capital loan that can be used to help the borrowing company prosper.

An SBA 7(A) loan for working capital may have a 7 to 10-year term, as opposed to a 12-month term as described in the example above.

The extended length of terms significantly decreases the amount of monthly principle that the borrower is obligated to pay back. In addition, an SBA loan will most likely come with a lower interest rate.

To demonstrate the significance of extended terms and lower interest rates, let’s go back to the original example from above, except this time John goes through an SBA lender and secures a 7-year working capital loan with 8.0 percent annual interest.

A $175,000 loan with a 7-year term and 8.0 percent interest will call for 84 payments of $2,728. With the same assumption that John’s business earns $8,333 a month ($100,000/12). It’s evident that the business is in a far better cash situation at the end of the 12 months as compared to the previous 12-month loan (see Chart 2 below).


A short-term working capital loan can be the right choice for a small business. An influx of capital may be just what a business requires in order to grow or strengthen the company’s cash position. However, before taking on short-term debt, take some time to fully understand the terms of the loan. As demonstrated in this article, the terms of a short-term working capital loan can be the difference between succeeding and failing.


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