Have you ever thought to yourself, “If I just had enough working capital, I could push my business in the right direction?” Well, the good news is that there are ways to bring in working capital from the outside and grow your business. You will need a strategy, though.
The In’s and Out’s Of Managing Working Capital
When looking at the health of a company, you can determine a lot by asking this one simple question: “How much working capital do you have?” The reason this question is so important is that working capital is a signal of a company’s operating liquidity. In other words, having enough working capital indicates that a company is able to pay for all short-expenses without tapping into other resources.
The amount of working capital your business has — to an extent — determines your credit-worthiness. If you have lots of working capital, you’ll be viewed as a stable and responsible business. If you’re running low on working capital, then there will be lots of question marks surrounding your financial situation.
How Much Working Capital Do You Need?
Every business needs working capital, but the goal isn’t necessarily to obtain as much working capital as you can. Having too much working capital may actually be an indication that you don’t have enough assets invested for the long-term. So, what’s the sweet spot — and how much does your company need?
Unfortunately, it’s impossible to provide you with an accurate answer. So much depends on your current situation, growth goals, cash flow, profitability, and more. Look at your operating cycle and get a firm grasp on how long it takes to turn the revenue produced from a sale into cash that can be used to grow the business and pay off expenses.
If your operating cycle is longer than it should be, then you need an infusion of working capital. If your operating cycle is quite short, then you may only need a small amount of additional working capital to tide you over.
Based on your operating cycle and current financial situation, develop three sets of projections: conservative, moderate and optimistic. Review them carefully with a business analyst and then determine what you realistically need. You can then turn your attention towards obtaining working capital to meet your demands.
5 Ways to Obtain Working Capital
When it comes to obtaining working capital, there are a number of options. Understanding how these options align with your business is the key to leveraging the right opportunities. Here are a few common ways businesses procure working capital:
1. Bank Line of Credit
A line of credit is one of the preferred options for businesses looking to procure some working capital. While a line of credit is often hard for a new business to obtain, companies that are well capitalized by equity (and have good collateral) can sometimes qualify.
With a bank line of credit, businesses can borrow funds when the need arises and repay once accounts receivable are collected from the short-term sales period. A line of credit is usually extended for a year and is expected to be paid off within 30 to 60 days of the funds being used.
2. Private Line of Credit
A line of credit is ideal for businesses, but most won’t be able to receive them from a bank. They require stacks and stacks of documentation and months of processing. The good news is that there’s an alternative.
A private line of credit works much like a bank line of credit, but requires fewer hoops. Many private financers promise faster approval processes, limited paperwork and decisions that are independent of personal credit. In other words, you get the same benefits of a traditional line of credit, but don’t have to spend months filling out paperwork and tracking down documents.
3. Trade Creditors
Have you established good relationships with trade creditors? If so, it’s not unheard of for a business to solicit help in providing working capital for short-term needs. For example, let’s say you typically pay your creditors every 30 days. If you receive a big order that can be fulfilled, shipped and collected in 60 days, you may be able to obtain 60-day terms from your supplier.
In order to obtain working capital from a trade creditor, you’ll need to supply them with proof of purchase orders. It’s also not uncommon for the trade creditor to file a lien on it for additional security. However, if you’re confident that you can collect, there shouldn’t be any problems.
One option that businesses often aren’t aware of is factoring. Under this option, you fill an order, and the factoring company buys your accounts receivable and handles the collection process. This option obviously comes with less control — and is more expensive than other techniques — but is often used by new businesses with no other alternatives.
5. Short-Term Loan
Finally, you may qualify for a short-term loan. This isn’t typically thought of as an option for obtaining working capital, but it can serve the same purpose when a line of credit isn’t extended. These loans are frequently given out to handle seasonal inventory buildup. It’s not the first choice, but is better than nothing.
Tips for Managing Working Capital
There’s a time and place for monitoring long-term financial goals, but businesses must pay attention to short-term working capital in order to be successful. This is why working capital management is so important.
“Proper management of working capital involves trying to achieve a balance between minimizing insolvency risks and maximizing the return on your assets,” serial entrepreneur Ajaero Tony Martins explains. “It is also advisable for you to take note of the fact that while the long-term analysis of your finances is mainly focused on strategic planning, the process of managing your working capital deals with daily operations.”
With daily operations and short-term goals in mind, here are some helpful tips for managing working capital in your own business:
- Focus on forecasting. Cash flow forecasting is the key to effective management of working capital. Always take into account the unexpected and be pessimistic whenever possible. Unanticipated events will always arise and you’ll need a built-in cushion to sustain these issues.
- Handle disputes properly. Disputes with customers can end up costing you a lot of time, which directly impacts your ability to pay off your working capital. Always have concrete procedures in place for how to handle disputes. Not only is this important for your financial health, but it also plays a major role in customer service.
- Create contingency plans. Even with pessimistic forecasting and plans for handling customer disputes, there need to be contingency plans in place for other unexpected events that put your business performance at risk. Create contingency plans for anything and everything.
- Send out invoices sooner. Having trouble tracking down payments? Try sending out invoices as soon as possible. While 30 days has long been considered the norm for payments, don’t rule out the possibility of instituting 15-day terms. These terms are becoming more commonplace and can prevent cash flow issues.
How you manage your working capital will determine whether or not you have access to additional working capital in the future. Keep these tips in mind and never let down your guard; successful management of working capital requires acute awareness.
Putting it All Together
As a business, managing working capital is critically important in the pursuit of growth and profitability. Unfortunately, it’s often challenging to efficiently procure and manage. Keep these tips in mind and begin implementing frameworks and strategies that allow you to maximize capital in the present and the future. Your business depends on it!
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