Know Your Cash Requirements and Understand Common Sources of Working Capital
You’ve heard the term working capital, but what is it? The strict formula in the accounting world for working capital is:
Current Assets – Current Liabilities
Put more simply, working capital is the cash available to fund day-to-day operations, take advantage of opportunities, purchase assets and grow your business.
As a small business, you will inevitably face the dilemma of funding your business’ activity from sources other than profits or owner contributions. Depending on your particular industry and the reason your business needs additional capital, those sources can include the following options.
Common Sources of Working Capital
(ranked in terms of most recommended to least recommended)
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1. Better Cash Flow Management
Often, the first and best line of attack in generating more capital for your business is to understand and actively manage your cash flow. Look closely at activity in the following balance sheet accounts.
| Balance Sheet Account | Suggestion for Improving Cash Flow |
| Accounts Receivable: | When your customers owe you money and aren’t paying consistently within terms, evaluate your practice for extending credit and focus some resources on collecting outstanding customer balances. |
| Inventory: | If you carry inventory, analyze how long stock sits on your shelves and reduce that time. |
| Accounts Payable: | Review your credit terms with your suppliers to be sure your time to pay appropriately aligns with the time it takes your business to produce, deliver, invoice and collect from your customers. |
2. Equity investor
If your business is poised for growth and profits, you may be able to get additional entities to infuse capital into your business, giving your business instant capital, with little risk, or additional expense. The only downside is that you will have to share the profits of the company with more parties.
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3. Loans from Primary Financial Institutions and Government Programs
Lines of Credit
Obtaining a line of credit can be very helpful for small businesses. It can provide an on demand source of capital to help your business through seasonal fluctuations, or to support growth opportunities such as acquiring new customers or offering new products of which you would be unable to take advantage with your current level of free cash flow.
Term Loans
Term loans are a one-time receipt of funds that are paid back over a specific period of time. Unfortunately, the process for obtaining a loan for a small business can be rigorous and time-consuming. Also, applications are still often met with denial and may not be an option for your business. To find out more about the loan programs available by SBA go to https://www.sba.gov/category/lender-navigation/sba-loan-programs.
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4. Loans from Private Lending Companies
As traditional banks have become more risk averse in their lending, private lenders have become an alternative for businesses to turn to. While they generally command a slightly higher interest rate than traditional banks, they may be more willing to lend to companies with worse credit or collateral.
5. Internal Revenue Service
While it is not recognized as a lending source, you could get a loan from the IRS simply by managing your taxes. You can pay in less during the year while knowing to expect a larger balance due by your tax return due date. The IRS will charge you 3% on underpayment during the year. They will also charge you 0.5% each month after the due date the balance remains unpaid. But if you can’t get financing elsewhere, if managed properly, managing your tax payments can be an effective method of financing. Compared to the cost of other sources of working capital this a relatively inexpensive option.
Contact us if you use any of these in your financing:
- Credit Cards – unless you pay them off timely, the high interest rates of credit cards make them too expensive while accumulating debt.
- Short Term Emergency Loans from Private Lending Companies – these usually command very high interest rates.
- Factoring – a factor can pay you on your open receivables, less a discount, typically between 2 and 6 percent. But don’t be fooled by these low numbers, typically a 2 – 6% discount must be multiplied by 12 to get to the true annual interest rate – that’s a hefty 24 to 72%!
Plan First
In addition to the options explained here, there are many other sources of working capital, each with their own advantages and disadvantages. Deciding which one is best for your business has to begin with planning for your cash requirements by building a financial projection or budget that includes a cash flow forecast.
For help building a budget and cash flow forecast, click here for our contact information or send an email to sales@. We have helped many small businesses understand their cash flow cycles and plan for their short and long term cash needs.
