Ravi Chandran
Working capital needs are felt by every company which wants to grow and expand.
How do you calculate working capital needs?
Table of Contents
Working capital is current assets minus current liabilities.
Net working capital is current assets (Less CASH) minus current liabilities.
Net working capital is the ability of the company to receive cash from goods or services sold (either as a cash sale or under (AR) accounts receivables) less-off their need to pay off their suppliers, i.e. (AP) accounts payable.
What are the Main Components of Working Capital
- Trade Receivables.
- Inventory.
- Cash and Bank Balances.
- Trade Payables.
Why is working capital needed?
If a company receives cash slower than the need to pay out to their suppliers, then the company is short of working capital.
What are the 4 main components of working capital?
It’s a fact of life: your company needs capital to conduct business. Of course, the best way to obtain it is through sales. Sometimes, however, you need other, more immediate business finance solutions.
Different sources may be appropriate for different stages of growth. Start-ups often rely on family members, friends, or local associates for their cash capital needs.
As you grow and your company needs more cash infusion, you may need to turn to alternate sources. Once you have achieved a financial track record, you can turn to other sources such as Asset Based Lending or Commercial Loans such as term loan, credit line or temporary bridging loan.
If your company needs cash capital here are the major business finance solutions available and when to use them. It includes some options you may have overlooked.
Working capital through Venture Capital
One problem many new businesses face is raising sufficient cash capital. A business in its primary phase will also face a difficult challenge getting a bank loan. One alternative is venture capital. Venture capital firms offer capital in exchange for equity in a company. This type of financing is ideal for new businesses since venture capital firms focus mainly on the future prospects of a company when banks use past performance as a primary criteria.
Working capital from Asset Based Financing
In increasingly popular business financing solution is Asset based as a means of financing growth and providing working cash capital. Asset based financing is a general term whereby a lender accepts as collateral the assets of a company in exchange for a loan. At times, a director’s personal assets can be accepted as pledge for granting the working capital to the company.
Working capital through Long-Term Debt
Long-term debt is one of the initial financing avenues a company should pursue. Most long-term debt takes on the form of a loan where the interest and part of the principal are paid back in equal installments over the life of the loan. Sources for these business financing solutions include:
- commercial banks
- government sponsored loan programs
- private lenders
Lines of Credit
A line of credit loan is designed to provide short-term funds to a company in order to maintain a positive cash flow. Then, as funds are generated later in the business cycle, the loan is repaid.
This is a fairly popular business finance solution. Most commercial banks offer a revolving line of credit, where a fixed amount is available. As funds are used, the “credit line” is reduced and when payments are made, the line is replenished. One advantage of a line of credit is that the no interest is accrued until the funds are withdrawn, but the line is immediately available for the company’s cash flow needs.
Letters of Credit
A letter of credit is a guarantee from a bank that a specific obligation will be honored by the bank if the borrower fails to pay. Letters of credit are useful when dealing with new vendors who may not be assured of a company’s credit worthiness. The bank would offer a letter of credit as an assurance to the vendor of payment. Although no funds are paid by the bank, the credit requirements for a line of credit and a letter of credit are similar.
There are many avenues for your business if your company needs cash capital. There are many loans in the market for small business owners and not all products may be the best fit for your business. What’s worse is, taking an unsuitable loan could be a huge setback to you personally, as well as to your business. So, an important factor is, work with your lender to determine the type of loan that fits your needs.
It is perfectly normal for successful businesses to borrow money and be in debt. Every company needs capital and also, borrowing money to make money is not really a new idea.
A successful business has to borrow money because before a single sale can be made, there needs to be something to sell. Every business needs some form of investment before it can start trading. This could be as simple as a computer, a telephone and an internet connection. But most need more: stock, premises, marketing and something to pay the staff, even if it’s a sole trader.
Over time, the business can finance working cash capital out of profits, but this only comes after a period of successful trading. If the business is growing quite fast, the capital required could always be ahead of the surplus generated from trade, meaning continual borrowing is needed.
After knowing every company needs cash capital, including yours, asking how much it costs to borrow money is often the wrong question. The right question is: “What is the difference between how much you can make and how much it costs to borrow?”
Company owners can of course refinance their private homes for equity term loan if they qualify.
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