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Intro to Working Capital
Working capital finance is one of the most important types of financing for businesses because it represents a company's short-term financial health. Your business can use working capital loans to fund day-to-day operations; they are essential to maintaining cash flow.
There are a lot of elements to think about when obtaining a working capital loan. The most crucial factor is the purpose of finance. Other factors to consider are the finance terms, the interest rate, and the repayment schedule.
The best way to find the right type of working capital finance for your business is to speak with a financial advisor. They can help you understand the different types of financing and how they can benefit your business.
If you are looking for a working capital loan, contact us today, and we can help you find the right type of financing for your business.
Working capital is the difference between what you own and what you owe.
What is Working Capital?
Working capital is a crucial financial metric indicating financial health and solvency. It represents the company's ability to pay its short term obligations and the difference between its current assets and liabilities.
Positive working capital indicates that a company has more assets than liabilities and, therefore, can pay its debts. A negative working capital suggests that the company has more liabilities than assets and may have difficulty paying its debts.
How is Working Capital Managed?
You can manage working capital through various methods, including account receivable management, inventory management, and accounts payable management.
Account receivable management involves collecting payments from customers promptly. Inventory management entails keeping inventory levels low to reduce storage costs and improve cash flow. Finally, accounts payable management entails paying suppliers on time to avoid penalties and interest charges.
You can calculate your working capital over a short or long period.
Working capital can either work over a short-term or long-term period. You can use short-term finance to fund the day-to-day operations of a business, such as inventory, accounts receivable, and payroll. Conversely, long-term finance can support the long-term growth of a business, such as expansion or acquisition.
One of the most common types of working capital finance is trade credit. Trade credit is an arrangement between a buyer and a seller. The seller supplies the customer with goods or services, and the customer pays for them over an agreed time rather than upfront.
What are the Benefits of Positive Working Capital?
Maintaining a positive working capital has several benefits, including improved liquidity, solvency, and profitability. A company with positive working capital can pay its debts when they are due, which allows it to maintain its credit rating and avoid defaulting on loans. It is also less likely to experience financial distress as it is more profitable. The increased profits can be reinvested in the business, pay down debt, or distributed to shareholders.
Companies with a positive working capital are more profitable.
What are the Consequences of Negative Working Capital?
Several consequences of negative working capital include increased borrowing costs, decreased profitability, and financial distress. A company with a negative working capital might have to pay higher interest rates as lenders perceive the company as being a higher risk. The decreased profitability can make it difficult for the company to reinvest in its business or pay down its debt. Negative working capital puts the company at risk of experiencing financial distress due to lower profits, leading to bankruptcy and liquidation.
Companies with a negative working capital are more likely to get into debt.
How to Calculate Working Capital
You can calculate your working capital by looking at the amount of money the business has and is owed and subtracting what it owes. For example, you may be owed money from a customer but owe money for supplier invoices and bills. Taking these expenses away from what the customer owes leaves you with money to spend on your business; this is your working capital.
Working Capital Loans
Working capital loans are the perfect solution for when businesses are waiting on payments from customers but need to make payments to suppliers in the meantime. This type of finance solves the problem of a business having more liabilities than assets.
Businesses use working capital loans to free up cash that is tied up in their debtor book. This type of finance is also known as receivables finance or debtor finance.
Working capital loans are beneficial to ensuring your company can maintain positive working capital.
Invoice financing is a popular type of working capital finance. With invoice finance, you can borrow money from a lender based on what your customers owe you. Waiting for your customers to pay what they owe and risking incurring late payment fees from your suppliers can endanger your business. To avoid this, the lender offers you cash up front and collects the customer payment on behalf of the business. This releases the money tied up in the invoice and allows the business to make the payments required to their suppliers. As the lender works with your customers directly, they will know you are using a finance facility.
If you didn't want your customers to know that you were using a finance facility, you could use invoice discounting. Discounting is similar to invoice factoring, but the lender gives you cash based on a percentage of the invoice and you continue to deal with your clients directly.
If you consider taking out working capital finance, it is important to compare different lenders to find the best deal. Other lenders will offer different rates and terms. You should also consider how much you need to borrow and how long.
Benefits of Working Capital Loans
There are several benefits of working capital loans, including:
- Releases cash that is tied up in unpaid invoices
- Allows businesses to make payments to suppliers
- Can be used by businesses of all sizes
- Alternative to traditional bank loans
If you are waiting on payments from customers but need to make payments to suppliers, working capital finance could be the perfect solution for your business. This type of finance releases cash tied up in unpaid invoices, allowing you to make timely payments to suppliers.
Paying suppliers on time and avoiding debts and late payment penalties is crucial for healthy working capital.
What is Liquid Cash?
Liquid assets are important as they allow a business to meet its short-term obligations. Liquid cash is a business's money on hand to pay its bills. It includes cash in the bank and any investments you can quickly convert into cash, and is another way of describing working capital.
You can quickly convert your current assets into cash, such as inventory and accounts receivable. Non-current assets, such as buildings and machinery, cannot be easily converted into cash.
You can calculate your working capital by subtracting a company's current liabilities from its existing assets. This figure represents a business's money to pay its short-term obligations.
How to Increase Working Capital
There are several ways to increase/manage your working capital, such as:
- Reviewing inventory levels and reducing excess stock
- Collecting receivables more quickly
- Negotiating longer payment terms with suppliers
- Obtaining a working capital loan
Investing in your company will increase the company's assets, thus its working capital.
Managing your working capital is an integral part of running a successful business. Increasing your working capital will improve your short-term financial health and give you the resources you need to grow your business. Each business is different, so you should try to find the management strategy that works best for you.
- Healthy Working Capital
You should always aim for healthy working capital; this doesn't necessarily mean high. If your working capital is very high, it can suggest that the business isn't investing its surplus cash, hindering growth. The business should make the most of its assets by investing in opportunities.
Your working capital will likely fluctuate with the seasons - this is natural.
To maintain healthy working capital, keep an eye on your finances so you are aware of where your money is going. Ensure you are paying all your bills, debts and suppliers on time and, if necessary, you can consider a working capital loan.
Ensure you are making payments on time to maintain healthy working capital.
Companies' working capital is a critical financial metric to measure their solvency and financial health. Companies should manage their working capital efficiently to avoid the consequences of negative working capital, such as increased borrowing costs, decreased profitability, and financial distress.