The importance of working capital is obvious: if you don’t have any, then you could find yourself unable to meet your financial commitments and pretty soon staring into the abyss.
But why are fast-growing companies with great prospects particularly at risk? Simple: it’s because when they take on new clients, they have to invest in new people, processes and raw materials – all before they get paid. If those cherished new customers turn out to be slow or unreliable payers, the company could find itself in a world of trouble.
However, a lack of working capital can also be a sign that your business has started to decline. This could be because order volumes are decreasing or because your day-to-day operations have become inefficient and require streamlining. And as already indicated, it can be a warning that your customers are becoming ever slower in paying their bills.
Do you have enough working capital?
There are two ways to answer this crucial question.
The first is to work out your current assets and current liabilities, which can be gleaned from your balance sheet. Then simply apply this formula:
Working Capital = Current Assets – Current Liabilities.
You can also look at your working capital ratio by dividing your current assets by your current liabilities. If the resulting figure is below one, you have negative working capital and are heading into trouble. But what’s the sweet spot? Anything between 1.2 and 2.0 is pretty good. Anything less and it’s time to consider a working capital loan.
Protect your business with a working capital loan
A working capital loan is a loan intended to finance your everyday operations, rather than to invest or buy long-term assets. There are a number of different possibilities, depending on your precise needs:
A short-term loan
As its name suggests, a short-term loan is intended to be repaid within months to years rather than years to decades. It can be either secured or unsecured, and will usually involve consistent, structured repayments comprising both capital and interest.
A business line of credit
Similar to an overdraft, a line of credit is a flexible borrowing facility with a defined limit: you can borrow and repay at will. It’s much more flexible than a loan, but as a result will probably attract a much higher interest rate.
A merchant cash advance
This interesting solution allows you to borrow a defined sum and repay it via a portion of your daily credit card sales. The advantage is that you will never struggle to meet a fixed monthly payment when sales are depressed. The drawback? The huge cost.
Invoice factoring and discounting
These innovative solutions allow you to tame a troublesome cash flow forever – you can borrow against the value of your invoices as soon as you issue them (at Cashsolv, we’ll lend up to 85%).
Repayment is then made when your customers pay you. With factoring, we’d assign experienced credit control professionals to deal with your debtors, thus minimising the interest you pay, whilst with invoice discounting you retain control of your own debtor ledger.
Cashsolv are the experts in small business finance. To discover how we can help you hit the sweet spot, please visit our business finance page.