Positive cash flow is extremely important for a small business to thrive, and while your business may be making more than it spends every month, you may not be seeing the full picture. Sure, staying “in the green” on a month-to-month basis is great, but it’s only a short-term glimpse into your small business’s financial well-being.
The long-term health of your business may look different when you factor in working capital, which, if you’re able to increase, could improve your ability to grow your business over time.
But what exactly is working capital? It’s important. In fact, it could be the difference between your business’s ability to stabilize or its inevitable collapse. So let’s look at what working capital is, how it’s calculated, and what it means for your business’s future.
What Is Working Capital?
Working capital is what your business has on hand to cover day-to-day business, including liquid assets and cash. Sufficient working capital allows your business to fulfill orders, pay staff, acquire customers and carry out the hundreds of other tasks to maintain and grow your business over the long term.
Working capital is also what comes into play when most of your customers are making monthly payments on an expensive product. If you sell used cars, for example, you’re selling something expensive that most of your customers can’t afford in a lump sum. So, you probably offer a payment plan where your customers can pay a portion of the car’s price every month over time.
If demand for your cars increases, you’ll need liquid capital to purchase more inventory to meet the high demand for your cars. But if you don’t have enough working capital, your business could get stuck in a financial pickle, where you have plenty of customers willing to pay, but no capital to purchase cars to meet the demand. Having more working capital is what can help prevent a situation like this and keep your business operating efficiently.
How Is Working Capital Calculated?
There is an accounting formula for calculating your business’s working capital – you take your business’s current assets and subtract its current liabilities.
What Is The Working Capital Formula?
Here’s the basic working capital formula:
Current Assets – Current Liabilities = Net Working Capital
“Current assets” are things like:
- Cash in business bank accounts, like checking, savings and CD accounts.
- Accounts receivable that are outstanding and owed to the business.
- Stocked inventory.
- Short-term investments, like stocks and bonds that the business holds in another company.
- Interest payable (if your business has loaned money to other businesses).
“Current liabilities” look more like:
- Short-term loan payments that are going to be due within the calculation period.
- The portion of long-term loans that you’re paying off during the calculation period – use a loan amortization schedule to find this amount.
- Accounts payable – what your business currently owes vendors and suppliers for goods and services.
- Other accrued expenses for the calculation period, such as loan interest, taxes and wages.
When you find that your business has positive net working capital, that’s great! This means that your business has good short-term liquidity and enough cash and liquid assets to pay off short-term liabilities. Plus, it means your business is cash-flow positive in the short term, which means you can grow faster.
Obtaining Working Capital Through Traditional Vs. Marketplace Funders
If your calculations show that your business is in need of more working capital, there are a few ways to obtain it.
Traditional lenders typically have a longer, more difficult process from start to finish than marketplace lenders. They’re not too keen on small business loans and require a lot of paperwork just to consider your business as a worthy investment.
Traditional lenders also have an 80% denial rate because the regulated structure of the modern banking system favors large, stable investments over smaller, riskier ones, which most small businesses are considered.
Rapid Finance and other marketplace funders, on the other hand, have much faster application processes, their financings are designed around the needs of your small business, and they offer many more financing options. There is usually far less paperwork, and the application process is entirely online.
And most marketplace funders are able to approve 60 – 70% of their applicants. With a more efficient application process, approval rates exponentially higher, and more financing options than traditional lenders, marketplace funders offer an all-around more pleasant experience for your business.
Small Business Financing To Increase Your Working Capital
Business Line Of Credit
A business line of credit is highly flexible and can act as a safety net for your business. You’ll have it when you need it, but you’re not obligated to use it. Qualifying is easy. You’ll typically need to have been in business for at least 1 year and have $50,000 in annual revenue. Lines of credit can range from $5,000 to $500,000 with interest rates starting around 8%.
Business Credit Card
Just like a line of credit, business credit cards are desirable for their flexibility, convenience and avoiding interest if the money isn’t being used. Some cards offer an introductory 0% APR, which usually lasts for 12 months – it’s a great benefit to have, but you’ll have to start paying interest once the 0% APR period is over. Other cards offer rewards and/or cash back. When you pay off your card regularly, you can enjoy some of these benefits.
Merchant Cash Advance
Many businesses are not as prepared as they’d like to be for unexpected increases in demand (like the car sales example above) or some kind of famine. A merchant cash advance can help your business access the capital it needs during emergencies or sudden rises in demand, or opportunities. The funding company purchases at a discount the business’s future account receivables.
Term Business Loan
With a term business loan, your business can borrow money upfront and pay it back with either daily, weekly or monthly payments. They range in size and start at $5,000 and go up to $1 million.
- Invoice Factoring
When you have unpaid customer invoices, you can turn them into cash with invoice factoring. This is not a loan. Rather, you can sell your invoices at a discount to a factoring company in exchange for the capital you need now.
An SBA loan is similar to most loans, only it’s partially guaranteed by the Small Business Administration (SBA). Typically SBA loans have a low interest rate.
To learn more about SBA and many other loan options, please visit our blog, “How Does A Business Loan Work?”
When it comes to financing your small business, your net working capital is what can be the difference between short- and long-term success. If your business needs working capital, there are many options available to you. Marketplace funders typically have a more streamlined process and higher approval rates than traditional lenders.
If you have questions or you’re ready to get started with business financing, please feel free to contact us.
To learn more about navigating your business through COVID-19, continue here:
- 8 Ways You Can Prepare Your Business For Success After COVID-19
- The Future Impact Of COVID-19 On Small Businesses