Most owner-managed businesses do not fail because they are unprofitable. They run out of cash while profitable, because the money is tied up in inventory sitting on a shelf and invoices customers have not paid yet. A working capital facility is the instrument built for exactly that gap. It is the least glamorous product a bank offers and, for a growing business, usually the most important one.
What a working capital facility actually is
A working capital facility, also called an operating line or a revolving line of credit, is a pool of borrowing you can draw down and repay repeatedly. You pay interest only on what you have drawn. Unlike a term loan, there is no fixed repayment schedule chewing through principal every month, because the facility is not meant to be paid down permanently. It is meant to breathe.
The logic is that the borrowing is self-liquidating. You draw to buy inventory, you sell the inventory, the customer pays, and the receipt repays the draw. On a healthy facility the balance rises and falls with the season and touches zero at least once a year. A facility that never comes down is not funding working capital. It is funding losses, or it is funding fixed assets that should have been financed with a term loan, and lenders read a permanently drawn line as one of the clearest early warning signs in their portfolio.
This is different from the working capital concept that shows up in a transaction, where the argument is about how much of it should be left in the business on closing. If you are heading toward a sale, the working capital adjustment mechanism is a separate topic worth understanding on its own.
How lenders size an operating line
Two methods dominate, and which one you get depends mostly on the size and sophistication of your business.
The first is a simple cash flow test. For smaller facilities, often under one million dollars, a bank will size the line off your trailing earnings and your operating cycle, sometimes as a straightforward multiple of monthly sales. It is quick, it is cheap to administer, and it comes with a general security agreement and usually a personal guarantee.
The second is a borrowing base, and it is the more common structure once facilities get larger. Instead of lending against earnings, the lender advances against specific current assets and re-measures that pool every month. It costs more to administer and demands more reporting from you, but it flexes with the business rather than being reset once a year.
The borrowing base, explained
A borrowing base is a formula. It takes your eligible current assets, applies an advance rate to each category, and the total is the maximum you may have drawn on any given day.
Accounts receivable typically advance at seventy-five to eighty-five percent. Inventory advances lower, commonly twenty-five to fifty percent, and finished goods draw a better rate than raw materials, which draw a better rate than work in progress. Progress billings and unbilled work usually get nothing.
The word doing the work is eligible. Receivables over ninety days are excluded. So are amounts owed by related parties, by customers who are also suppliers to you, by customers outside Canada and the United States unless insured, and often anything owed by a customer who represents more than a set share of the total book. That last exclusion catches owners off guard constantly, and it is one more reason customer concentration costs you twice, once in your borrowing capacity and again in your valuation.
A worked example. Say you have $2.0 million of receivables, of which $250,000 is over ninety days and $150,000 is owed by a related company. Eligible receivables are $1.6 million, and at an eighty percent advance rate that supports $1.28 million. Add $1.2 million of inventory, of which $800,000 is finished goods at a forty percent advance and $400,000 is raw material at twenty-five percent, and you add another $420,000. Your borrowing base is $1.7 million, even though the balance sheet shows $3.2 million of current assets. The gap between those two numbers is the part most owners have never calculated.
What it costs
Operating lines are floating rate instruments, priced as a spread over the lender’s prime rate. A well-secured facility at a chartered bank might price at prime plus one to prime plus two and a half. A borrowing base facility with a non-bank lender will run materially higher, and an asset-based lending facility higher still, because the lender is doing more work and taking more risk.
Look past the headline rate. There is usually a standby fee on the undrawn portion, typically a quarter to a half percent, which is the price of having capacity available. There are annual review and renewal fees. On borrowing base structures there are monitoring fees and the cost of periodic field examinations, where the lender sends someone to test your receivables and count your inventory. Add these up before comparing two offers on rate alone, because on a modestly drawn line the fees can matter more than the spread.
Covenants and reporting that come with the line
Expect monthly reporting rather than annual. A borrowing base certificate, an aged accounts receivable listing, an aged payables listing, and an inventory summary, usually due within fifteen to thirty days of month end. Miss these repeatedly and you will find your facility under review regardless of how the business is performing.
Financial covenants generally include a current ratio floor, a debt to tangible net worth ceiling, and often a fixed charge coverage test. There will also be negative covenants restricting additional debt, liens, dividends, and shareholder loan repayments without consent. The dividend restriction surprises owner-managers who have historically paid themselves through dividends, and it is worth negotiating explicitly rather than discovering after the fact. Our note on how loan covenants work goes through the mechanics of testing and cure rights.
When a term loan is the better answer
Use the operating line for things that turn into cash within a year. Inventory, receivables, seasonal payroll, a large order that needs funding before it ships.
Do not use it for equipment, leaseholds, a building, or an acquisition. Those are long-lived assets and they belong on long-dated money. Funding a five-year asset with a demand facility that the lender can call is a structural mismatch, and it is the single most common financing error we see in owner-managed businesses. If you are weighing the two, the comparison between a line of credit and term debt sets out where each one fits, and acquisitions have their own logic covered in how to finance a business acquisition in Canada.
Why owner-managed businesses get this wrong
Three patterns recur.
The first is asking too late. Owners approach the bank when the line is already fully drawn and payables are stretched, which is the worst possible moment to be negotiating. The time to increase a facility is when you do not yet need the increase.
The second is under-asking. An owner requests exactly what today’s shortfall is, gets it, and is back nine months later. Lenders do not enjoy repeat increase requests, and each one is a fresh credit decision. Size the facility for where the business will be in eighteen months.
The third is poor presentation. Two businesses with identical financials get different answers because one arrives with a clean aged receivables listing, an inventory report that reconciles to the general ledger, and a rolling thirteen-week cash flow forecast, and the other arrives with a year-end statement and a verbal explanation. What lenders look for is less mysterious than owners assume, and most of it is within your control.
Getting the line approved
Build the file before you make the request. Interim financial statements no more than sixty days old. Aged receivables and payables. An inventory listing broken into raw materials, work in progress, and finished goods. A thirteen-week cash flow forecast showing peak draw. A short written explanation of your operating cycle: how long from buying material to shipping product, and how long from shipping to getting paid.
Then explain the request in terms of the cycle rather than the shortfall. A lender hearing "we need $500,000 because we are tight" is being asked to fund a problem. A lender hearing "our cycle is one hundred and ten days from purchase to collection, our peak season requires $2.1 million of inventory in March, and the line closes that timing gap and repays by August" is being asked to fund a mechanism. The second request gets approved more often, at better pricing, on the same financials.
It is also worth running a competitive process rather than accepting your incumbent’s renewal terms by default. Facilities are repriced every year and there is more variation between lenders on operating lines than on almost any other product, particularly between the chartered banks, the credit unions, and the private credit market.
Frequently asked questions
Will I have to give a personal guarantee?
On most owner-managed facilities, yes, at least in part. Guarantees are sometimes capped at a fixed amount rather than unlimited, and they can occasionally be reduced or released as the business builds equity and a track record. It is a negotiable term, not a fixed one, and it is worth negotiating at origination rather than hoping to revisit it later.
Can I have an operating line and a term loan with different lenders?
Technically yes, but it creates a priority contest over the same collateral and most lenders will resist. Where it happens, the two sign an intercreditor agreement setting out who ranks first on which assets. In practice it is simpler and cheaper to keep the senior debt with one institution.
What happens if my borrowing base falls below what I have drawn?
You are in an over-advance position and you must repay the excess, usually within a few days. This is why the certificate is filed monthly. It typically bites when a large receivable ages past ninety days or a major customer stops paying, which is exactly when cash is already tight.
Is an operating line callable?
Most are demand facilities, meaning the lender can require repayment on notice. In practice lenders do not call performing loans without cause, but the legal right exists and it is the main reason not to fund long-term assets on a line. Committed facilities, which cannot be called absent a default, exist but cost more and are more common at larger sizes.
How much should I ask for?
Model your peak working capital need over a full seasonal cycle, add a buffer of roughly twenty to twenty-five percent, and ask for that. If your peak inventory and receivables total $2.0 million against $600,000 of trade payables, your peak need is $1.4 million and the facility should be sized around $1.7 million to $1.75 million.
Next steps
If your operating line has not been reviewed in over a year, or if it never seems to come down, both are worth looking at now rather than at renewal. KitsWest Capital advises owner-managed businesses across British Columbia and Alberta on debt and capital structure, and we run competitive processes for operating and term facilities rather than negotiating with a single lender.
If a sale or a transition is anywhere on the horizon, capital structure and value are connected, and an exit readiness assessment or an independent business valuation is a sensible starting point. Speak with an advisor to talk through where your facility sits today.
