Working Capital Financing

Working capital financing is the source or sources of money required by a company to keep its business operating.

Working Capital Formula

Working capital = Current (short term) assets – Current (short term) liabilities

Current liabilities of your business are things like trade creditors (accounts payable), bank overdrafts and tax liabilities.

Current assets of the business are things like raw materials, work in progress, finished goods inventory (stock) and trade debtors.

When you take current liabilities from current assets you have your working capital: The amount of money you are using to keep you business running.

The best businesses concentrate hard on optimizing working capital. If you need less working capital financing, then naturally this will cost less in finance charges.

Banks and other lenders look hard at your working capital control before they will extend you a loan. What they look at is known as liquidity ratios.

When working capital is positive it means that the company has enough potential cash to meet its immediate obligations. They look for a ratio of twice as many current assets as liabilities.

If you’ve got negative working capital then you owe more than you’ve got and you’re going to be in trouble before you know it.

Cash Conversion Cycle

Studying the cash conversion cycle of your business can transform your working capital requirements.

If you think about it, from the time you have to pay for raw materials to the time it takes you to receive your cash from your customer all needs financing.

Working on initiatives to shorten these times can seriously enhance your wealth and relieve stress. Simple things like taking deposits from customers, negotiating with suppliers for credit terms, and implementing effective accounts receivable collection strategies will all make a difference.

Beware the Overdraft

Many businesses have come undone in times of tight credit – like at the time of writing this – as bank overdrafts are immediately callable, and this can jeopardize an otherwise successful business endeavour.

It is much better arrange your working capital financing through more permanent financing sources, as you will always need some. Equity, term loan, or accounts receivable factoring are all established ways of funding working capital requirements.

Overtrading

It’s surprising to many new business owners, but if you are growing quickly, then you will need more working capital financing as requirements grow with your business turnover.

If you don’t get the working capital financing arrangements in place first, then you can suffer from what is known as overtrading, and you go bust.

By monitoring your working capital as a percentage of turnover, you can quickly learn how much you need, and how much you will need given any business scenario.

Natural Growth Rate

The profitability of your business will determine how fast you can expand. This is because the profits determine how much new working capital is created from normal trading.

Naturally if you are more profitable then you can support more growth, but if your planned grow rate exceeds what is possible, then you will need additional working capital.

You can see this often in the stock market when businesses raise new equity from shareholders to fund overseas expansion, or build new stores etc

Top of Working Capital Financing

More About Working Capital:

Find out the essential disciplines of Working Capital Management

Tighten up your Cash Flow Management

How Accounts Receivable Factoring can raise needed working capital.

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