How to Increase Your Business Working Capital
Commercial businesses in all industries share a common need: the ability to finance operations to keep business running smoothly and generate profit. Since the 2008 credit crisis, banks have increasingly restricted credit to small and medium-size companies in favor of serving larger corporations. If you run an SMB you understand the incredible challenge of maintaining self-financing over a prolonged period. So, how do you best manage working capital?
Let’s start with the basics.
What is working capital?
Working capital is a financial metric that measures a company’s operating liquidity over 12 months. It is the amount of cash and other short-term assets that remain available after all of the company’s short-term liabilities are accounted for. Positive working capital means that a company’s current assets outweigh its current liabilities and indicates strong short-term financial health.
Why is working capital important?
Working capital is the lifeblood of a business. It enables a company to meet its short-term financial obligations and fuel growth.
What is working capital used for?
Working capital is used to meet all company financial obligations within the coming year, such as:
- Purchasing inventory
- Paying short-term debt
- Meeting operating expenses
How do you calculate your company’s working capital?
Working capital is the relationship between current assets and current liabilities. Following is the formula to calculate working capital as a dollar figure:
Current assets: assets that are convertible to cash in less than a year
Current liabilities: financial obligations that are due within one year
How does a company increase access to working capital?
When you develop a viable strategy to increase working capital for your company, you’re setting your business up for success both now and into the future. Too often, businesses approach financing and cash flow management without a complete understanding of all available options.
Lines of credit and selling equity are not the only ways to increase working capital. Simple changes to cash flow management can quickly free up needed cash and alternative funding options create easy access to working capital.
Why is bank financing no longer a viable option?
Bank loans to SMBs have become practically non-existent since the 2008 credit crisis. Small businesses require small loans and therefore are not as profitable to banks as larger corporations. Since these businesses are riskier and less profitable, they usually hit a brick wall when seeking bank financing. If you apply for a commercial line of credit, in all likelihood your company will be denied.
If your application for a commercial loan is accepted, be prepared to be managed by the controlling hand of the bank. Be sure to understand all the implications of the loan agreement and the obligations tied to it.
At minimum, the bank will insist on analyzing your balance sheet and income statement on a regular basis. It could also require bank approval on all major financial decisions that you make. Further, the bank will likely impose additional covenants that force the borrower not to exceed certain financial ratios or control certain activities such as limiting dividend payment options. Other bank covenants will outline a strict payment schedule, impose a minimum level of working capital, enforce carrying specific insurances and more.
It is clearly understood that banks demand and wield the upper hand when your business needs funding. Understanding the terms of your loan agreement and the covenants that apply are critically important. This is critical prior to committing your company’s future financial health to the control of your bank.
In the absence of commercial lending as a viable funding solution, SMBs need to find alternative sources to access working capital.
Alternative lending options
The bank’s retreat from lending to SMBs has led to the emergence and popularization of specialized non-bank lenders. These companies are dedicated to providing alternative funding options designed specifically for small and medium-size businesses. Invoice financing companies are particularly well suited to meet the funding needs of this market sector.
What is invoice financing?
Working capital does not necessarily equate to a company’s ability to sustain day-to-day operations. The problem is that current assets often cannot be liquidated soon enough to support immediate financial obligations. In this case invoice financing is the ideal solution by making accounts receivable readily convertible to cash.
Is invoice financing expensive?
Invoice financing is a cost-effective means of creating positive cash flow and improving working capital. The rate is determined by using a few basic criteria such as:
- Accounts receivable volume
- Average collection period
- Customer concentrations (diversity of the customer base)
What are the benefits of invoice financing?
In addition to improving cash flow, invoice financing provides additional value-added benefits to support your business.
- Professional accounts receivable management: Experienced A/R professionals can effectively work with your customers to improve collections.
- Dispute resolution: An invoice financing company can act on behalf of its client to manage disputes.
- Enhanced risk management: Gain access to credit advice and information to better assess the creditworthiness of new customers. Avoiding bad debt leads to greater financial stability.
The solution is liquidity
Working capital is a measure used to determine a company’s ability to manage its financial obligations for the next 12 months. But business runs on a day-to-day basis with costs pending weekly and monthly. The challenge for many small to medium-size companies is how to access working capital when the commercial banking system is simply not an option.
The key to the solution is liquidity. This can be accomplished by improving work practices to create liquid assets or by use of alternative funding options such as invoice financing. Companies need to have the funds necessary to maintain daily operations. It takes money to make money.