Working capital is the money that is useful to handle any day to day expenses and essential for every successful business growth. There must be enough capital in hand to run the daily operations on a smooth basis. It is always crucial to invest money into growing the business. In some businesses, the key to efficient working capital management lies in understanding the working capital equation and reducing unnecessary expenses. In other businesses, working capital loans are the only option to maintain steady cash flow. It is essential to understand what, when and how a working capital loan helps business growth and the different types of working capital loans in the market. With a proper understanding and research on the working capital, one can choose the right working capital business loan and make the productivity of business increase.
What is working capital-
Working capital will be the difference between current assets and current liabilities which enables to cover business expenses daily. The working capital loans or operating capital loans will allow in the smooth running of everyday business operations. These loans will cover the working capital needs if the business faces any trouble to cover up ordinary business expenses due to fluctuations, business growth spurts, or any other crisis.
- Current assets: The short term assets are the assets or cash that will be cash by the end of the financial year. For example accounts receivable or inventory
- Current liabilities: The business debts that are payable in the coming twelve months are short term loans and payable accounts.
Working capital is essential as it is required to measure the amount of money that is left to run a business after accounting for all short term liabilities. There is an equation which enables to determine the working capital of a business.
Current liabilities – Current assets = Working capital
How much working capital does a business require-
Any individual will require a working capital that will be sufficient and surplus to cover up the business expenses as well as to pay off debts. The other important aspect is to use the asset to further invest in the business. It will depend on any requirement and need of any individual based on their business expansion and growth.
Working capital liquidity-
When an individual plans or thinks about working capital, it is essential to have a consideration on the working capital liquidity. One must always have in mind that every current asset will not be in the form of cash. It is essential to have working capital liquidity in the mind as it will help in knowing the amount of working capital that is available to use.
Working Capital Ratio-
There is one way to gauge the efficiency of the business and financial health. It is a calculation derived by using the working capital ratio. The working capital formula is,
Working capital ratio = current assets / current liabilities
The working capital equation will help in identifying the sweet spot between paying expenses and existing debts and simultaneously preparing for the growth in future business. The equation above will enable us to figure out the amount for borrowing in a working capital loan.
Reasons for availing a working capital loan-
There are many reasons for availing a working capital loan as it depends on the business and industry of the individual. The most common reasons involved in availing a working capital loan are,
- Inconsistent Cash Flow- When a customer takes more time to pay up the invoices, or any inventory takes more time to turn over, the cash flow of business will suffer. The inconsistent cash flow will make it very difficult to make the payment of bills on time as well as to run the business smoothly. A working capital loan will always give access to money when there is a need.
- Seasonal Sales Fluctuations- Working capital loans will always come to the rescue of any seasonal businesses that need to pay business expenses when the sales are slow. The seasonal businesses might make use of the working capital loans to purchase inventory before any demand or rush for increased sales.
- Business Growth Spurts- Every new startup and growing businesses face difficulty in making every end meet. Working capital loans will help new businesses cover everyday expenses, pay their employees, invest in growth, hire recruits, and marketing their business.
- New Business Opportunities- It is always worse to pass on a huge business opportunity because of lack of funds. A working capital loan will help in the purchase of new equipment, invest in training, or provide resources to expand the business, and take advantage of any arising excellent opportunity. It will also enable them to take on the projects that are a brilliant investment in the long run which might not have an immediate payoff.
- Cash Cushion- Working capital loans act as a cash cushion when there is no room for any anticipated expenses or financial crisis. It will be an emergency fund that will ensure a business to deal with any emergency.
Types of Working Capital Loans
Working capital loans are of different forms as they are suited to specific needs and requirements of business nuances. The financial situation and need of the individual will decide the best suiting working capital loan. The different types of working capital loans are,
- Instalment Loans- The instalment loans are also known as term loans which are issued to the borrowers in a lump sum manner. The borrowers are supposed to repay the amount with interest in regularly scheduled instalments. Instalment loans are an excellent choice for every established business which are looking for long term loans to finance the working capital. The financial lenders offer a quick loan process and easy disbursal of funds with attractive interest rates for working capital term loans.
- SBA Loans– SBA is the Small Business Administration, which is a government organisation that helps in business through loan programs. The 7a loan is one of the popular loans, which is essential for many business purposes that includes the working capital. SBA will assure a portion of the loan, and when there is no sufficient collateral necessary to avail a low-cost loan, 7a loan will be the right choice of investment. Since the government backs the SBA loans, they will be more challenging to qualify for any individual and the process for application is lengthy. The eligible businesses can qualify for a loan with a lower interest rate and longer terms.
- Lines Of Credit- With the help of a line of credit, one can gain access to a certain amount of money. The individual can draw from the line of credit at any point in time. The lines of credit are revolving as one pays off debts; it can be drawn from the fund again. It can be the best way to achieve a more steady cash flow. These loans will help businesses that are unsure about the amount to be borrowed or that will require a cash cushion for expenses. The revolving lines of credit will ensure the business with quick access to funds without any assistance from other loans.
- Short-Term Loans- These loans are also known as cash flow loans or fixed-rate loans. They are issued to borrowers in a huge lump sum and are supposed to pay back in fixed instalments over a shorter period. The short term loans have fixed fees rather than interest charges. The short term business loans for working capital is a smart option as most of the working capital needs are short term and need not require many years in paying back the loan. These loans are easy to qualify when compared to other medium or long term loans which will make it a good option for growing businesses.
- Invoice Financing- One cannot always get the business clients to pay the invoices on time. It does not mean one has to be stuck with them for payment. The invoice financing is a term for invoice factoring, and such loans will have invoices as collateral. Both the above options will allow utilising the unpaid invoices to access immediate funds for working capital. When it is a B2B business that is struggling with inconsistent cash flow because of slow-paying customers, invoice finance will be beneficial for business.
Eligibility and Comparison of Interest rates-
The working capital loan rates and eligibility will vary with every financial loan provider in the market. There are a set of requirements to be satisfied to avail the best rates and tenures for the working capital loan for business growth. The financial capacity of the business venture, as well as the repayment capability, is evaluated. The lender will look for productivity if the business ventures to offer the loan with comfortable rates.
Working capital is a significant key element to run a business operating smoothly. An individual can maintain consistent cash flow by planning effectively and wisely with constant watch over the assets and liabilities. Some crucial times in business will require financial assistance, and working capital loans will save from any crisis and financial emergency. There are many working capital products which enable to manage the business effectively when it comes to any seasonal sales, interrupted cash flow or any expansion of the business.