What is Working Capital?
Working capital is vital to every single business in any industry. Without working capital, well, you really cannot run a business because you will not be able to cover any costs! Working capital is a common measure of a business’s liquidity, efficiency, and overall health. In accounting terms, working capital is the amount of current assets minus the amount of current liabilities (current assets – current liabilities = working capital). Current assets are a business’s cash which include currency, checking accounts, and petty cash, as well as other assets such as temporary investments, accounts receivable, inventory, supplies, and prepaid expenses. Current liabilities are an obligation that is typically due within one year of the date of a business’s balance sheet that will be repaid through the use of a current asset. Current liabilities include notes payable, accounts payable, and remaining current liabilities such as payroll taxes payable, income taxes payable, and interest payable. When calculating the working capital for your business, anything below one indicates negative working capital, while anything over two indicates that the company is not investing excess assets; however, just because your business has high amounts of working capital does not necessarily mean that a business is functioning well because some of those current assets could be put to better use! Basically, a company needs just the right amount of working capital to function optimally and cover day to day cash requirements.
Why Working Capital Matters
Positive working capital is necessary for your company to meet its daily needs. Having access to working capital regularly can influence your company’s ability to meet its debt obligations, as well as to remain financially viable. Whether your company is starting out in the entrepreneurial world or well-established and looking to grow, you need working capital. As a business grows, much of the cash ends up getting tied up in day to day operations to keep the business running, but these vital costs are essential to staying afloat in every industry. Positive working capital generally indicates that a business is able to pay off any debt or short term liabilities almost immediately, whereas negative working capital shows that a company is unable to do so. There are so many different business industries in the United States today, so remembering that where your business would need to allocate working capital may vastly differ from another business – but no matter the industry, finding ways to consistently cover day to day operations, as well as having enough working capital for emergency situations, is essential for any business to thrive.
When Would a Business Need Working Capital?
Working capital loan options are always a viable way for any business to generate enough capital to cover daily operational costs, especially when your business is small or just starting out. When covering day to day costs, many small business owners resort to using personal resources, such as personal bank accounts and assets, to fund important costs like payroll. This may seem like a good idea to many business owners who are worried about taking out loans, but a more efficient way of running your business would be to consider establishing a working capital loan to keep money in your business, as well as your own pocket. Many business owners are unsure of what they can use a working capital lending option for, so listed below are a just a few areas that working capital finance options can be allocated towards:
- Buying inventory, especially to prepare for peak seasons, is essential in any retail business. However, sometimes coming up with enough up front capital to cover these costly expenses can be difficult, so reviewing the different lending possibilities can help.
- Hiring new employees is always essential. Whether your business is looking to grow and expand and find a need for extra help, or your business has limited access to skilled and qualified employees so you must spend more to cover costs of those high paid workers, there are always working capital advances that can help keep your business running smoothly.
- Financing day to day operations is an obvious use for working capital financing, but the definition of day to day operation finances will vary from industry to industry. Whatever the daily operational costs are for your specific business industry, there are always options other than resorting to personal assets, such as SBA loan choices.
- Covering slow periods in any business can be difficult for business owners, especially when the slow period was unexpected. Just because your business is experiencing slower income periods than usual does not mean you can just forfeit all daily costs, so making sure to have some form of financing available to your business is essential.
- Seasonal dips in revenue can be annoying for many business owners, but this is typically a working capital expense that can be foreseen. If you know your business generates more capital during the holidays, resulting in slower revenue generation during the following months, then looking into finance options ahead of time to prevent any issues is vital. There are a variety of lending possibilities for your business.
- Covering expenses after dealing with many late customer payments, which is typically noticeable during economic downturns, can cause many unexpected issues for business owners, especially if your business as relying on steady customer payments to keep your business afloat. During these unexpected situations, considering finance options such as merchant cash advances to obtain capital quickly could be the answer.
- Equipment costs for many businesses is essential – if you own a business in the construction industry, tow truck industry, machine shop industry, or even the baking industry, then you know how essential working equipment is. Looking into different equipment loan possibilities will help cover these necessary costs when your business does not have enough up front working capital.
- Marketing is incredibly important in every single industry today thanks to the growing dependency on technology in our society. The best way for any business to grow and retain great customers is through the use of marketing strategies. Most business owners utilize marketing companies to help with this complicated, but much needed, task; this quickly becomes a daily expense for business owners.
- Payroll is unavoidable in every industry, especially because if you do not pay your employees due to lack of working capital for whatever reason, many employees will become dissatisfied, therefore leading to either unmotivated workers or to employees simply quitting. Using lending options to cover staff payroll costs is always doable.
Types of Working Capital Loans
| Types | Rates | Terms | Funding |
|---|---|---|---|
| Bank | 6-10% | 3-7 years | 14-30 days |
| SBA | 6-10% | 3-7 years | 10-30 days |
| Line of Credit | 5-15% | 1 – 3 years | 7-30 days |
| Alternative | 6-25% | 1-5 years | 5-7 days |
| Cash Advance | 1.16-1.55 | 3-24 months | 1-3 days |
| Invoice Finance | 1-2% weekly | 1 – 90 days | 1-3 days |
Working Capital Bank Loans
While not easy to obtain by any means, a working capital bank loan or line of credit offers the best rates and terms of all financing options. But if time is a necessity, a bank working capital loan probably wouldn’t make sense, being that the process can take more than a month to complete. Therefore a line of credit makes the most sense because once the facility is approved the business will have readily available financing at their disposal whenever they should chose to use the LOC. One of the great aspects of a business line of credit is the fact that interest only accrues on the amount of money the business uses — not the entire prequalified funding amount.
- Rates: 5-10%
- Terms: 1-25 years
Working Capital SBA Loans
There are a lot of similarities between bank working capital and SBA working capital. Both types of business financing may take a long time to get approved and funded, but there are some SBA loans with an expedited funding process. SBA working capital loans are simply loans provided by traditional lenders in which the Small Business Administration agrees to cover much of the lender’s losses should the small business default. Traditional SBA 7(a) working capital loans may take a month or more to fund, a smaller part of the 7(a) program provides funding much faster. The SBA Express loan program allows lenders to use their own paperwork and make own credit decisions, and the SBA approval process has a 36 hour turnaround. End result: an SBA Express can fund within two business weeks. The program can fund both term loans and interest-only lines of credit.
- Rates: 6-8%
- Terms: 3-25 years
Alternative Working Capital Loans
For whatever reason a business may not qualify for more traditional financing, or don’t have the time to wait around for a long funding process. For those companies a smart choice would be to use mid prime alternative business loans or institutional lenders. Alternative business loans offer small businesses affordable credit solutions with rates much lower than cash advances, with longer terms than cash advances (1-5 years) but with shorter terms than bank financing. Another nice aspect of alternative business loans are the fact they may be used to bridge SBA financing because they rarely have a prepayment penalty.
- Rates: 9-26%
- Terms: 1-5 years
Asset Based Working Capital
Asset based business loans are used by many companies that need working capital but don’t have the necessary credit or profitability to get approved by more traditional lenders. Asset based lender will use a company’s commercial real estate or business owner’s personal real estate as collateral for working capital financing. Even if a company or business owner has a 1st or 2nd mortgage, an asset based lender can still provide financing of up to 50% of the property’s equity.
- Rates: 8-25%
- Terms: 6 months – 3 years
Working Capital Cash Advance
Cash advances aren’t really a type of loan but instead the sale of a company’s future revenue in return for immediate financing at a discount to the unsecured business lender. Business cash advances come in two forms: MCA loans and ACH advances. A MCA loan is the sale of a company’s future credit card receivables. To repay the lender the merchant will allow the funder to remit a percentage of each days credit card sales until the loan is repaid in full. An ACH loan is the sale of a company’s future bank deposits. Repayment is made daily by having a fixed amount remitted via ACH from the company’s bank account until it is repaid on a date to be determined before funding.
- Factor Rates: 1.16-1.50%
- Terms: 4 months – 2 years
