Working Capital Finance
A Guide To Working Capital Finance
Working capital finance is the key to the financial health of your business. Find out how it works.
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Author: Gary Hemming CeMAP CeFA CeRGI CSP
20+ years experience in business finance
Working capital finance is designed to provide a cash injection into your business to cover operational costs by boosting cash flow.
In simple terms, it’s a cash injection into your business bank account that gives you breathing space.
What is working capital finance?
Working capital finance is additional funding taken out to increase the working capital available to a business. It’s generally used to improve business cash flow either through a single cash injection or by offering additional revolving credit to a business.
The idea behind working capital finance is to increase the amount of cash available to a business to free up business operations and allow it to move quickly. Effective use of this approach sees the business use the funds, either as a one-off or as an ongoing source of funding, to support business operations that are otherwise profitable, but cause slow cash flow.
This approach is often used to cover standard operational costs of a business, such as meeting payroll, covering office expenses, rent and other costs associated with regular trading.
The different types of working capital finance
While working capital finance is used as a term to describe the funding available, it can actually broken down further. Some of the products that are often used for this purpose are:
Business loans
Business loans allow you to borrow a cash lump sum and repay it over a fixed period – usually between 1-5 years. If you’re looking to raise funds quickly, then an unsecured business loan will allow you to borrow up to £250,000 in just a few days.
For larger amounts, consider a secured business loan, which can take 1-3 weeks to complete but may allow you to borrow higher amounts.
Invoice finance
Invoice finance allows you to release cash from the invoices that have been issued to their customers, but are not yet due. For businesses who operate on delayed payment terms, invoice finance acts as an ongoing source of funding that grows as your business does.
Invoice finance facilities can be broken down into 2 main products. The first is invoice factoring, which includes full credit control support from your funder and is generally favoured by smaller companies or those who suffer from poor credit control.
Invoice discounting works in a similar way, but leaves credit control in the hands of the borrower.
Invoice finance is a great option for those looking for ongoing support in boosting working capital, but your maximum borrowing to the amount owed on outstanding invoices.
Asset finance
Asset finance is traditionally used to fund the purchase of new assets or equipment for a business. Although it is traditionally a tool used as equipment finance, for those looking to boost their working capital position, it can still work well.
This is through a product called asset refinancing, which allows you to release funds from the assets already held by your company.
This approach does have a benefit over an unsecured business loan, as a personal guarantee isn’t usually required.
Merchant cash advance
For businesses that accept card payments, a merchant cash advance could allow you to borrow a cash lump sum quickly. It works by allowing you to borrow against your future card receipts, so if you take a large amount this way, this could be a strong option.
Also known as a business cash advance, this is a flexible way to borrow. Your maximum borrowing will be decided by the amount you take in card payments each month, not your total turnover – usually up to 120% of your monthly card receipts.
If you have a more even split in your takings or want to borrow more than this amount, either consider other products, or even combine then. For example, an overdraft and a merchant cash advance could work well and give you a split of revolving and non-revolving credit.
Overdrafts
An overdraft simply allows you to take your bank balance into the negative and pay interest on the amount borrowed for the privilege.
An overdraft is usually offered by your business bank account provider, although some third party providers do exist.
The big drawback is that the credit limits offered on overdrafts tend to be quite low and interest costs fairly high, so use an overdraft sparingly.
Revolving credit facilities
Revolving credit facilities work in a similar way to overdrafts, but operate as a separate facility with a different provider.
They usually come with a simple online platform that allows you to log in and transfer funds over to your main business bank account.
Interest is usually charged only on the funds drawn down and in most cases, you can draw down and repay funds as needed throughout the month.
Trade finance and supply chain funding
Both trade finance and supply chain finance are designed to offer ongoing support to your cash flow and work in a similar way to invoice finance.
Both products are types of working capital financing that are commonly used by businesses that are reliant on physical stock.
Trade finance is often used to fund international trade as either import finance or export finance.
Supply chain finance is used to fund the purchase of stock that will ultimately be sold on to another buyer. When you have a creditworthy buyer, you can leverage their reliability to raise finance based on the payment that they will make to you. This allows you to offer them delayed payment terms, while still getting your stock immediately, improving your cash flow position while speeding up your trading.
How do working capital loans work?
Working capital loans work by releasing funds to your business to improve your business cash flow, allowing you to fund standard business operations.
Different types of lending will work slightly differently – as mentioned above – but the concept is largely similar.
The advantages and disadvantages of using finance to boost working capital
- Improved cash flow will greatly increase your options when trading.
- It’s generally quick and easy to raise funds to bolster your working capital requirements.
- Cash is a crucial factor in growing a business, so a cash flow boost can really help.
- Most facilities are very flexible, and there are plenty of options available enabling you to choose the best fit for your business.
The disadvantages of using finance to boost working capital
- When taking out finance, you will inevitably need to repay it, increasing your outgoings.
- If you fail to repay the facility, your business credit score will drop.
- You may be required to sign a personal guarantee (depending on the type of borrowing you take out).
Frequently Asked Questions
Why is working capital so important?
Working capital is the lifeblood of any company. With poor trading performance, but sufficient working capital, a business can afford to ride out the problem and improve performance.
With strong trading performance but poor working capital, the business could fail despite being profitable.
For this reason, it is one of the most important factors in predicting a business’ ability to survive or even grow.
What is considered as good working capital?
Good is a difficult thing to define as too little clearly risks a company being unable to meet its obligations. On the other hand, holding too much cash on account can be seen as a sign that the business isn’t investing enough in future growth.
The perfect amount will depend on your sector, fixed and variable expenses and future plans. That said, a cautious approach is generally best here, so it’s better to too much cash on account than too little.
Is borrowing for working capital just papering over the cracks of a poor business?
No, not necessarily. In many industries a solid investment can prove costly, but increases underlying profitability.
For example, if a business took on a very large contract that caused significant upfront expense, but didn’t bring any money in for 90 days, it could cause poor cash flow, but increases profitability. In this situation, poor cash at bank isn’t a marker of a poor business, but is simply a symptom of growth.
How can I better control my working capital?
The key is to control your cash flow through proper financial controls, forecasting and financial management. For an in depth guide to this subject, read out guide to business financial management.
What types of business require the most support with their working capital?
Common industries that require support in this area are recruitment businesses, haulage, printing and manufacturers – although any business can require support depending on their circumstances.