Working capital finance
Working capital
finance is business finance designed to boost the working capital available to
a business. It's often used for specific growth projects, such as taking on a
bigger contract or investing in a new market.
Different businesses
use working capital finance for a variety of purposes, but the general idea is
that using working capital finance frees up cash for growing the business which
will be recouped in the short- to medium-term.
There are many
different types of lending that could be considered
working capital finance. Some are explicitly designed to help working capital
(whatever industry you’re in), while others are useful for specific sectors or
requirements.
Here are some of the
more common types of working capital finance.
Definition
Working capital is the amount of cash a business can safely
spend. It’s commonly defined as current assets minus current liabilities.
Usually working capital is calculated based on cash, assets that can quickly be
converted to cash (such as invoices from debtors), and expenses that will be
due within a year.
For example, if a business has 5,000 in
the bank, a customer that owes them 4,000, an invoice from a supplier payable
for 2,000, and a VAT bill worth 4,000, its working capital would be 3,000 (5,000
+ 4,000) - (2,000 + 4,000).
Liquid cash
Working capital is seen as ‘working’ because the business can
use it — in other words, it’s not tied up in anything long-term. Whether you
want to buy stock, invest in the business, or take on a big contract, all of
these activities require working capital — cash that’s quickly accessible.
On the other hand, if your business is profitable but has big
bills to pay soon, your working capital situation could be worse than it might
seem — or could even be negative.
Working capital loans
Working capital loans are normally over a short or medium term,
designed to boost cash in the business to go after new opportunities. The size
of the working capital loan you can get depends on many facets of your business
profile.
Secured working capital loans will require assets to use as
security, so the amount you can borrow is restricted by the assets available.
Meanwhile, it’s possible to get unsecured business loans up to £250,000
to help with working capital — but for these loans your credit rating will be more important, and
you’ll often have to give a personal guarantee.
Overdrafts
Overdrafts have traditionally been a useful source of working
capital finance for many businesses across all sectors, but they're hard to get
with a business bank these days. On the alternative finance market there are lots
of flexible business overdrafts, which are a
great way to finance working capital at short notice when you need it.
The downside of using overdrafts for working capital is that
they often have low credit limits, which might limit your plans. They’re
effectively a form of unsecured lending, so even if you’re lucky enough to get
one, the limit is likely to be fairly low unless your business has a strong
history.
Revolving
credit facilities
Similar to overdrafts, revolving credit facilities give you a
pre-approved source of funding that you can use when you need. But the key
difference is that with a revolving credit facility you don't need a specific
bank account with that provider — you can direct the money wherever you need
it.
The best part is that with many providers, once they're set up
you only pay interest on outstanding funds, which means they can sit idle for a
few weeks but are ready to go at a moment's notice. That makes revolving credit
facilities a useful safety net to have in place.
Invoice
finance
For businesses that offer credit terms to their customers, invoice finance is a common type of
working capital finance. Along with other types of receivables finance, invoice
finance is based on money owed to your business, and you normally get a
percentage of the value owed via one invoice or the entire debtor book.
Factoring includes credit control, and is
often favoured by smaller companies with lower value invoices, whereas discounting and selective invoice finance are other
potential options for larger companies with creditworthy customers.
Although invoice finance is a good way of unlocking working
capital in the short-term, the amount you borrow is (by definition) limited by
the value already owed to you via customer invoices — so it’s not necessarily
the right option if you need a more significant amount of money for longer-term
growth plans.
Trade finance and supply chain finance
Trade finance and supply chain finance work in a similar
way to invoice finance. They’re both types of working capital financing
designed for businesses that focus on physical stock rather than services
rendered.
Supply chain finance is a mutually beneficial arrangement based
on the creditworthiness of buyers, where the buyer can delay payment for longer
while the supplier gets payment from the lender immediately (the payment delay
is shouldered by the lender, rather than the supplier).
Trade finance is a more complex finance partnership that facilitates
international trade, and often involves arrangements like prepayment for the
shipment of goods from overseas manufacturers.
Asset
refinancing
If you can’t get enough funding via an unsecured business loan, you can often use
assets in your business to raise finance via an asset refinance.
Asset refinancing is based on valuable assets in the business,
so you won’t usually be required to offer a personal guarantee or involve your
personal home. Like invoice finance, the amount you can borrow depends on the
value of the items used to secure funding against.
Merchant
cash advances
If your business accepts payment from customers using card
terminals, a merchant cash advance is another useful way to increase working
capital. The product gets its name simply because it’s a cash advance for
merchants — meaning businesses like retailers, pubs, cafés and restaurants are
all suitable.
The amount you get advanced is normally expressed as a
percentage of your average monthly card revenue (e.g. 120% of an average
month), and critically, repayments are taken as a percentage of future card
revenue too. That means repayments can feel relatively painless because they’re
taken at the source.
Conclusion
There are many types of working capital financing available, and
choosing the right product depends on your sector and circumstances, as well as
what you're trying to achieve. To find out more about working capital
financing, browse the related articles below or get in touch.
Fixed capital is the capital which is
invested for long terms that means it remains in business for long time period
i.e. For several years
Working capital is the capital which is
invested for short term that means it remains in business for short time period
i.e. mostly for a year.
Liquidity:
Fixed capital assets have low liquidity
since they are costly and require extensive asset disposal methods.
Working capital assets usually have more
liquidity since they can promptly be changed over into cash.
Frequent requirement:
Fixed capital is not needed frequently
in business. Its requirement is there when a company needs to do any large
investment like spreading out of business or acquiring of more fixed assets.
Working capital is needed frequently in
business to complete its daily transactions like buying of raw materials,
paying wages and so forth.
Source:
The primary source of fixed capital
includes debentures, shares and long term loans.
The primary and fundamental source of
working capital includes fixed deposits, profits held by company, short term
loans, debentures and shares.
Quantity:
The fixed capital is needed more in
quantity as compare to working capital.
The working capital is needed less in
quantity as compare to fixed capital.
"Four differences between Fixed
capital and Working capital is given below.
Fixed capital:
It refers to the capital invested in the
long term assets of the company. Money is never invested in this type of
capital.
To establish a company or business,
fixed capital is vital.
The finance for this type of capital is
obtained from long-term debt.
Fixed capital serves strategic
objectives.
Working capital:
It refers to the "capital
invested" in the current assets of the company. Money is the major
investment of this "type of capital".
To run and maintain a company or
business, "working capital" is vital.
The finance for this type of capital is
obtained from short-term debt.
Working capital serves operational
objectives."
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