Working capital is vital to keep a business running smoothly. It provides a ready source of cash to cover day-to-day operating expenses during the coming year. When people talk about working capital, they’re generally referring to net working capital, an indicator of whether a business can meet its short-term financial obligations. Net working capital is the difference between current assets and current liabilities, and it can be positive or negative.
- Permanent – or fixed – working capital is the minimum amount of cash or current assets needed to meet all current liabilities, regardless of any fluctuation in business activity.
- Temporary working capital – also called variable, fluctuating or cyclical working capital – is the difference between fixed working capital and net working capital.
Other working capital terminology includes:
- Regular working capital – the minimum amount needed in normal circumstances to cover current working expenses such as supplies and materials, and overhead costs like wage payments.
- Reserve margin working capital – a safety net of funds set aside for unpredicted circumstances such as a strike, redundancies, or a natural disaster.
- Seasonal working capital – extra funds a business needs to operate during its peak season of product demand
- Special working capital – a type of temporary working capital, this covers exceptional circumstances such as a works accident or new product development.
How to raise working capital
Different companies turn to working capital finance for a variety of reasons, but generally to free up cash for growing the business. Working capital finance is often used for projects such as investing in a new market or taking on a bigger contract.
Ways to raise working capital include:
1. Working Capital Loans
Working capital loans – usually on a short- or medium-term basis – typically enable businesses to pursue new opportunities. The amount of money you can access depends on many aspects of your business profile.
Secured working capital loans are limited by the value of business assets you can put up as collateral.
Unsecured business loans, on the other hand, may allow companies to borrow up to £250,000 to help with working capital, although your credit rating will be more important and you may have to provide a personal guarantee.
Historically a useful source of working capital finance for many businesses, overdrafts may now be hard to get from a business bank.
Alternative finance, which comes from lenders outside the mainstream, provides flexible business overdrafts to finance working capital when you need it at short notice, but they often have low credit limits.
3. Tax Bill Funding
Getting a loan to pay tax bills including VAT allows you to spread the cost so you’ll have more cash available for other things in your business.
4. Revolving Credit
Similar to an overdraft, revolving credit facilities give you a pre-approved source of working capital funding you can use when you need.
5. Invoice Finance
Invoice financing is based on the amount owed to your company, and you normally get a percentage of that value.
4. Asset Refinance
Like invoice finance, asset refinancing is based on assets in the business, so you won’t usually have to offer a personal guarantee.
Why is working capital important?
Many businesses fail not through lack of profits, but a shortage of funds for daily operations.
Having sufficient working capital to meet ongoing operating expenses avoids compromising everyday business activities. It allows you to continue paying suppliers and staff and fulfil other obligations such as taxes and interest payments, even if you run into cash flow problems.
Net working capital can be used to meet regular financial obligations such as:
- Property rent.
- Inventory costs.
- Research and development.
How much working capital does your business need?
The amount of working capital a business needs can vary widely.
It largely depends on the size and growth of the business. The bigger the business, the more fixed working capital it needs. Operating costs may also fluctuate seasonally or unanticipated short-term expenses may arise.
Ensuring the optimal level of working capital requires striking a balance between negative working capital and positive working capital.
With negative working capital, on paper your available short-term assets won’t cover all short-term obligations. Positive working capital does.
If you consistently have too much working capital, though, you may not be making the most of your business assets. This idle cash could be used for investing in the long-term future of the business.
In other words, your working capital should be no more and no less than the amount your business actually needs.
Business Finance V4B is a specialist business finance provider that can tailor a working capital solution that suits your business needs, visit our home page to learn more about our range of credit facilities.