Working Capital In Your Business
In simple terms, working capital can be defined as the current liquid assets available to a business on a day. Operating capital or working capital is also added to a company’s worth in addition to the fixed assets such as owned property or equipment while calculating their net worth. A working capital deficiency arises when the current liabilities of the company are more than the current total assets of the company within a fiscal year.
Adequate working capital is the most essential factor for growth of a small business. It is very difficult for a small business to grow without availability of adequate working capital. It is generally seen that small businesses need working capital as they mature to move to the next growth phase. Working capital finance allows small companies to move to the next stage of business without stressing the existing cash flow of the business.
Working capital finance arrangements can be both short-term and long-term. All of these arrangements work in different manner depending on the requirements of the business. Working capital can be used by a business to fulfill their contract obligations, expand facilities or to fulfill various purchase orders.
There are different types of working capital financing available to small businesses. It is very important for a small business to know about different types of financing available. Sooner or later, a small business is going to need working capital finance to grow further.
Working capital finance is a win win for both the lender and the business. The business wins as it gets the money needed for growth and the lender gets to lend the money against collaterals which can be quickly liquidated in case of default.
The article below describes, in detail, various types of working capital finance available to small businesses. Hopefully, this will help you in deciding the best type of working capital finance arrangement for your small business.
Accounts Receivable Financing
As the name suggests, it is the finance offered against the receivables of the company. It is also commonly known as A/R financing. The receivables in this case serve as the collateral against which the finance is provided.
It is a very innovative form of financing as it frees up the capital tied up in receivables for immediate use. It also transfers the risk of default of account receivables to the financing company. The money raised in this manner can be used by the business to run the daily operations of the business and concentrate on their core business of providing goods and services instead on spending time on collecting receivables.
A/R financing is also one of the most popular form of working capital finance for small businesses as the money available with this form of capital financing is usually enough to take care of their day to day operations.
Purchase Order Financing
It is another innovative form of working capital financing. It is commonly known as P.O. financing. It is usually a short-term arrangement. Under this form of financing, money is provided by lenders to businesses that need money to fulfill the big purchase order placed by government agencies or national retailers.
When a producer receives a large purchase order but does not have the required funds to purchase the raw materials, purchase order financing comes to the rescue.
In this case, the lender takes a look at the credit record of the business which has placed the order. In case, the end customer has the necessary funds and has a track record of paying the bills on time, arrangement of P.O. financing is not going to be a problem.
Most of the times, this type of financing is used by small businesses that receive occasional big orders which cannot be fulfilled by their existing cash flow. Money made available to businesses under this form of financing eases the cash flow situation and allows the business to fulfill the order.
It is a financing option for businesses that need to expand their working facilities for increased production of goods.
In this particular type of financing, money is offered to the businesses for purchase of new equipment as well as space for expansion of manufacturing facilities. Sale-leaseback is also common in this type of financing.
Lenders also offer financing for big industrial projects wherein the business pays back the money from the cash flow generated by the new business.
Businesses that need working capital and have contracts in place with their customers can take advantage of the contract financing to fulfill their working capital needs.
In this form of working capital financing, businesses raise money on the work contracts signed with their customers. This allows small businesses to have enough money for their day-to-day operations. The money is paid back when the payments from a work contract start flowing.
This form of financing is often sought by businesses who have signed a larger than usual contract and do not have the means to fulfill their obligation with current working capital. Contract financing provides them with immediate working capital which allows them to manage their business and also fulfill the large contract.
This particular form of financing is different from other types of financing as it has been specifically designed to help small businesses advanced capital on the contract did work before the work is done.
These are various types of working capital finance options available to small businesses. In addition to these, lenders can offer various other innovative financing depending on the orders as well as current financial condition of the small business.
Your choice of a particular type of working capital finance should be based on the liquid assets available to your business against which money can be raised as well as the cost of raising money against various assets. Lenders may also offer varying interest rates depending on the choice of the asset offered for collateral. A more liquid asset may attract a lower interest rate than an illiquid asset.
Hopefully, the above information will help you in choosing the right type of working capital for your small business.