What Is

Working Capital?

What Is

Even the most successful businesses struggle to keep up with daily operational costs while seeking sustainability and growth, both of which require working capital.

Working capital is essential to successfully evolve and maintain a business. Owners need enough working capital to account for emergencies, cash outflows, and opportunities when they arise. Whether it’s expansion, seasonal demand, new technology, or hiring employees, having available capital makes all the difference in business’ success.

WHAT IS WORKING CAPITAL?

Working capital is the amount of liquid assets your company has available. To calculate this, take the value of current assets (cash, accounts receivable) and subtract the current liabilities (accounts payable, accrued expenses).

Funds go out to cover business expenses and working capital keeps the operation running.

An easier way to think about it is the accessible assets available between the days a business pays for things and when the business has new income.

It’s possible to improve your working capital by making adjustments that shorten the accounts receivable collection time, keeping accounts payable low, and shortening the amount of time allotted to debtors.

However, most businesses cannot finance their operating cycle with accounts payable financing alone. This shortfall typically needs to be covered by the net profits generated initially or by external funding.

Filling In the Gap

One important factor for any small business is planning ahead. Your business might go through experiences where there’s a need for short-term working capital. Getting caught off guard can cost you a major client or important sales opportunity.

Four financing options that offer businesses short-term working capital financing are:

A Business Line of Credit:

If your business is well capitalized by equity and has good collateral, it has a high chance to qualify for a line of credit provided by a bank. This line of credit allows you to borrow funds for short-term financing. With a business line of credit, you don’t start paying any money back until you draw from the funds. As you pay the money back, the amount available returns to the initial funds. In order to obtain a business line of credit, your business needs to have exceptional credit scores and a track history of success.

Benefits of A Business Line of Credit:

  • Fast access to money
  • Generous credit limits
  • Easy money transfer


Small Business Credit Cards:

A small business credit card is a beneficial tool to use for more flexible working capital. Getting a small business credit card with cash back rewards is a great way to cut costs and earn money while spending money on everyday business expenses. Using a credit card for your business sends positive card activity to the business credit reporting bureaus. As long as you keep your credit utilization low and maintain other good financial habits, you’ll be able to qualify for more rewarding cards and financing in the future.

Benefits of a Small Business Credit Card:

  • Merchandise discounts
  • Purchase protection
  • Points or cash back expenses


Merchant Cash Advances:

You can obtain cash advances against your business’ future credit card sales. The lender then collects a set percentage of your credit card sales everyday until your advance is paid off. You don’t need to put up collateral for a merchant line of credit, but your business needs a well established credit profile to show your ability to pay them back.

Advantages of Merchant Advances:

  • High approval rating
  • No collateral is at stake
  • Your credit won’t be affected

Alternative Lending:

Alternative lending is the overarching term for small business financing options outside traditional banks. The Small Business Administration shows that only 1 out of 10 businesses are getting approved for financing from their bank, so private lending services have become a popular funding option. Whereas big banks have an approval rating between 13% and 20% over the past 5 years, alternative lenders have accepted on average between 61% and 64% of small business owners looking for funding. Fill out a free application online for alternative lending with FundKite here.

Perks of Alternative Lending:

  • Less paperwork
  • More flexibility
  • Faster funding


Lessons

Remember, the shorter the working capital cycle, the more effective a company’s working capital is. The longer the working capital cycle, the more time a company’s capital is tied up without earning returns. Small businesses should always strive to reduce their working capital cycle to increase their available liquid assets. Additionally, companies should always monitor their working capital ratio to ensure that they are investing excess assets whenever possible.

This guest post was written by Courteney Reed, a financial industry analyst dedicated to empowering people to make smart financial decisions.


Category: Small Business Funding