Working Capital Solutions

Working capital is the fuel that drives a company’s daily activities. It is one of the key performance indicators that highlight the success and health of the business. Working capital refers to the money a company uses to meet its short-term and operational needs and obligations. If the company cannot meet its short-term needs, its long-term future is most likely in question.

The working capital is also referred to as net current assets, operational capital or current capital. If a company has working capital challenges, there are possible solutions that you can consider to help you overcome them.

Why is Working Capital Important?

Working capital is essential for businesses for several reasons such as:

Liquidity

Working capital ensures that your company has enough cash and readily available assets to meet its short-term obligations, such as paying suppliers and employees. This liquidity can give the business a financial buffer during economic downturns or unexpected expenses.

Operational efficiency

Working capital can also help streamline the business's operations by optimising inventory levels, accounts payable and accounts receivables. It can ensure that resources are allocated efficiently, reducing waste and improving overall productivity.

Cost reduction

Enough working capital can also minimise the costs of holding excessive inventory or high debt levels. When you reduce the capital tied up in non-income generating assets, the business can improve profitability and return on investments.

Investment opportunities

Maintaining healthy working capital levels in the business allows you to seize growth opportunities such as expanding operations, investing in research and development or acquiring new assets. With sufficient cash at hand, you can capitalise on strategic initiatives without relying on external financing.

Risk management

Effective working capital also helps mitigate some of the financial risks associated with cash flow fluctuations, credit defaults, or supply chain disruptions. Companies can be better prepared for economic volatility and market uncertainties by closely monitoring and managing their short-term assets and liabilities.

Building and managing your working capital involves a careful balance of human resources and technology. Using inventory management software and techniques can ensure you don't carry too much stock while conducting regular audits to identify slow-moving or obsolete items. Taking necessary actions, such as offering discounts or returns, can help free up capital.

How Do You Know You Have Enough Working Capital?

The ideal amount of working capital depends on the size and risk characteristics of the business, as well as the volatility of the industry or business climate.

Larger firms need more working capital than smaller establishments. The best approach is to determine the amount of working capital buffer needed relative to either gross revenue or total expense.

What's more, the business should also consider its "burn rate" (the speed at which the working capital is reduced) to ensure it has enough working capital to cover its operating expenses in times of uncertainty.

Ideally, the working capital buffer should be 35% or greater of total expenses or gross revenue.

Getting the right Working Capital Financing Solutions

Businesses that find themselves with below-par working capital have several options they can consider to help them create the buffer they need. A whole spectrum of options is available, each with its own set of benefits and considerations. These options can be conventional or modern, but each has its benefits and downsides, and businesses should carefully consider this before settling for any of them.

Overdrafts

This is the classic choice for businesses looking to plug short-term working capital pitfalls. Overdrafts are a credit facility provided by your bank that allows you to temporarily spend more than what is in your account up to the agreed limits.

The upside with overdrafts is that they are flexible and easy to arrange. They offer immediate access to additional funds to help the business address cash crunches and cover operating expenses.

However, they have interest charges, and usually, additional fees are involved. Additionally, banks can withdraw the facility on short notice, making it unreliable for businesses that want to use it frequently.

Invoice financing

This is one of the more modern financing methods that businesses are turning to because of its convenience and practicality. With invoice financing, businesses can use their unpaid invoices to get funding upfront. The business simply sells the invoice to a financing company, which gives you a substantial percentage of the invoice's value upfront. The balance is paid once the customer clears the invoice, and the fees are deducted.

Invoice financing provides access to cash, can help improve cash flow, and doesn't require any property as security. Additionally, approval times are short, and businesses can finance as many or as few invoices as they want, reflecting their cash flow requirements.

Invoice financing does involve fees, and companies offering invoice finance focus on businesses operating in the B2B sector.

Asset-based lending

This is one of the oldest financing methods available. It is mainly offered by banks and is most suitable for businesses looking for substantial funds and extended repayment terms.

It involves using your business's assets, such as inventory, real estate, or equipment, as collateral for a loan. This financing model can provide the business with large sums of money, depending on the value of your assets. However, it has a lengthy and frustrating application process that makes it unsuitable for short-term funds needed within a short time. It also requires assets that can be used as collateral, which can work against new and small businesses.

Revolving credit facilities

A revolving credit is a type of loan that allows the business to withdraw, repay, and redraw funds within an agreed limit. It offers businesses great flexibility and access to funds when needed. However, it can have higher interest rates than other forms of funding, like traditional loans, and there may be additional fees for facility maintenance.

Closing Remarks

With many of these working capital solutions, say for invoice financing, the business is required to pay back the money. This means the business can solve its short-term needs but could create additional problems by increasing its overheads when it has to back the money.

Businesses should carefully consider the solutions and pick the ones that best serve their needs while keeping their interests and fees to a minimum.