Working capital finance: what it is, what it costs, and which kind fits your company

Working capital finance pays for the day-to-day: payroll, stock, the VAT bill, the supplier who wants paying before your customer pays you. It isn't one product. It's a family of them, and the right one depends on why the cash is short and for how long. The cost ranges from overdraft-style interest to advances that work out well over 100% APR, so the choice matters.

What working capital actually is

The British Business Bank describes working capital as the cash a business has left after money coming in and going out over a given period, the money that can be put to work straight away rather than being tied up in anything long-term.

The gap usually has one of four shapes:

• Timing. You've done the work and invoiced, but your customer pays on 60-day terms.
• Seasonal. You stock up for a peak, or carry costs through a quiet quarter.
• Lumpy bills. A Corporation Tax or VAT payment to HMRC lands in one go.
• Growth. A bigger order needs materials and staff before it pays.

Match the product to the shape. Borrowing 12 months of money to fix a 6-week gap means paying for 10 months you didn't need.

The main working capital products for limited companies

The British Business Bank notes that a bank can demand an overdraft back at any time, and that overdraft rates are typically higher than business loan rates and can change. That makes an overdraft fine for a dip that lasts weeks and a poor fit for a gap that lasts a year.

How the cost works, in pounds

Working capital products price themselves in different ways: an interest rate, a factor rate, a service fee plus a discount charge. The only way to compare them is to convert each one into the same unit: the annual cost of the money you actually receive.

A loan priced as an APR. £100,000 at 18% APR over 24 months, repaid monthly, costs £4,992.41 a month. You pay back £119,817.84 in total, so the interest is £19,817.84.

An advance priced as a factor rate. A factor rate is the fixed multiple you pay back, like 1.35. £50,000 at a 1.35 factor over 6 months, paid every business day, means £67,500 back in 126 payments of £535.71. The cost is £17,500, which works out at about 126% APR.

Look only at the totals and they seem close: about 20p in the pound for the loan, 35p for the advance. The APR tells the real story: the advance costs roughly seven times as much per year because you have the money for a quarter of the time. Sterling's take: the shorter the term, the more a flat fee hurts.

Who working capital finance suits

• Limited companies with steady turnover and a gap they can name and date.
• Businesses where the money earns more than it costs: stock that sells at a margin, a contract that pays on completion.
• Companies whose bank statements show the repayments are comfortable even in a slow month.

Who it doesn't suit

• A company covering a loss. Finance moves cash around in time; it doesn't make an unprofitable month profitable.
• A business already repaying two or more advances. A third one on top is how a manageable cost becomes a cash-flow problem.
• Anyone who can't say how the money comes back. If the answer is "next month will be better", wait.

Our funding partner's programmes suit limited companies trading for 12 months or more, turning over about £60k a month or more, with no CCJs or defaults in the last 12 months and two or fewer loans or advances running. Smaller companies (about £12k a month and 4 months' trading) can still ask.

What funders look at

• Companies House. Your incorporation date, filed accounts, confirmation statements, directors and any registered charges. Late filings are a warning sign to a funder.
• Bank statements. Usually the last few months of the business current account. Funders look at average balance, days overdrawn, bounced payments and existing finance debits.
• CCJs. A county court judgment stays on record for 6 years unless it's paid in full within a month, and it can make credit harder to get.
• Personal guarantees. For unsecured facilities, expect a director to be asked to stand behind the debt personally. The British Business Bank notes that an unsecured working capital loan will likely need one.
• Debentures. Some funders take a charge over the company's assets. It's registered at Companies House and shows up for any future funder too.
• VAT and HMRC position. Arrears to HMRC, or a Time to Pay arrangement, will be asked about.

Red flags

• An offer quoted only as "pence in the pound" or a factor rate, with no term attached.
• Up-front "admin" or "processing" fees deducted from the amount you receive. They raise the real cost because you pay for money you never get.
• Pressure to sign the same day.
• Anyone asking for a fee before an offer is made. See our funding scams guide.
• No clear answer on what happens if you repay early.

How to choose

1. Write down the gap: how much, from when, until when.
2. Work out what your company can comfortably repay each month with the calculator on this page.
3. Get every offer as amount received, total repaid and term.
4. Convert each one to an APR with the offer checker and compare like for like.