A working capital loan is intended to finance the day-to-day operations of a business, paying for such short-term investments as accounts receivable and inventory. These loans typically have a short life, with repayment required within a few months.
Working capital loans are most commonly used by businesses that experience highly seasonal sales, where the activity level spikes over a few months. They use the money to rapidly expand operations during the peak season. Once inventory has been sold off and the related receivables collected, the borrower has sufficient cash to pay back the loan.
A significant risk for the lender is that poor sales during the peak selling season could result in the borrower not generating enough cash to pay off the debt. Consequently, working capital loans have a higher interest rate than more traditional long-term loans, and usually require some form of collateral or a personal guarantee by the business owner.