Which Working Capital Solution is Right For You?
What exactly is working capital and how do you find out your business’ working capital needs?
Working capital is the amount by which current assets exceed current financial liabilities. To determine your working capital needs, you first need to examine your operating cycle. The operating cycle analyzes the fulfillment, accounts receivable and accounts payable cycles in terms of days. In other words:
- Fulfillment is analyzed by the average number of days involved in delivering products or services sold to a customer.
- Accounts receivable are analyzed by the average number of days it takes to collect payment from customers.
- Accounts payable are analyzed by the average number of days it takes to pay a supplier invoice.
Most businesses cannot finance the operating cycle (fulfillment days plus accounts receivable days) with accounts payable financing alone and, therefore, require working capital injection at some point. If your business experiences insufficient working capital, here are 5 potential sources of working capital financing:
If your business is a new startup in its first year of operation and has not yet earned profits, then you might be able to rely on equity funds as a short-term working capital solution. These funds can be procured from your own personal resources, a family member, a friend or a third-party investor. Make sure you think carefully before taking money from family and friends, as it could end up ruining your relationship if the lender doesn’t fully understand what they’re getting into. Take the time to explain to them about the risks and how startups work. Only after they are clear about the details and comfortable with the risks should you move forward.
Do you have a solid relationship with your trade creditors? If so, then you might be able to get their assistance in obtaining temporary working capital. If you have a consistent history of on-time payments, a trade creditor may be willing to extend terms so you don’t miss out on a big order. For example, if a big order comes in, you could request 60-day terms from your supplier instead of the usual 30-day terms. The trade creditor will ask for proof of the order and may require a lien on it as a safeguard.
Suitable for new and established businesses, factoring is another viable option for working capital financing. Once you have filled an order, a factoring company buys your accounts receivable invoices and then handles the collection of payment. Because it’s not a loan, factoring can give you quick access to the funds you need, with minimum credit requirements. By factoring your receivables, and having money available immediately, you are in a better position to pay on a timely basis other companies who have extended you credit.
Line of Credit
The upside: if your new business has equity and you have good collateral, your business might qualify for a line of credit loan, which allows you to borrow funds for short-term needs when they arise. Line-of-credit loans usually carry the lowest interest rate a bank offers since they’re seen as fairly low-risk. They are intended for inventory purchases, payment of operating costs for working capital and business operation needs.
The downside: Lines of credit are not often given by banks to new businesses. Also, they’re not intended for purchases of equipment or real estate. Finally, to negotiate a credit line, your banker will want to see current financial statements, your latest tax returns and a projected cash-flow statement
If your new business does not qualify for a line of credit loan from a bank, you might be able to obtain a short-term loan. However, this type of loan can be very expensive, keeping you locked in a debt cycle for a very long time. You may be left repaying the loan, plus the expensive fees and interest rates, with huge percentages of your revenue. Applying for a short-term loan should always be your last resort because this option is often the highest priced.
Although working capital can be confusing and complicated, a firm understanding of this concept is imperative to making any long-term venture successful. The important thing is to plan ahead and get matched with the best solution. Interstate Capital can answer all of your questions about working capital financing during a free consultation.
Find out more about working capital solutions from our trusted factoring experts today.