Your working capital is basically what your business can afford to spend once you’ve paid off all the current expenses. If it’s a positive figure, it means your business has the cash it needs to operate daily – and if it’s very positive, you may use it to grow the company.
The basic formula to calculate your current working capital is: current assets – current liabilities = current working capital. “Current assets” means cash or credit that you can easily turn into cash (for example, invoices your clients will pay within 12 months) and “current liabilities” are all the expenses your business needs to pay (such as rent, wages or debts that you have to settle within 12 months).
As you may have guessed at this point, the concept of working capital is very similar to cash flow (and operating liquidity).
What is working capital finance?
The term “working capital finance” doesn’t refer to a specific type of business loan. It’s about giving your month-to-month working capital a boost – perhaps during a period when a business is undertaking some special project. There are a series of business finance options you can choose from, and some of them are better than others for working capital fluctuations.
Business finance options can generally be divided into two main categories:
Revolving credit facilities. If your cash flow issues happen regularly, for example because your business’s revenue is tied to seasonal trends, they may be a better bet. They allow you to borrow money when you need it and can solve the problem permanently – but you do need to find the right option and make sure you don’t abuse it.
One-off borrowing. These types of business finance are more suitable if your need for credit is an exceptional circumstance – for example if something goes wrong unexpectedly (e.g. a piece of equipment suddenly breaks and you need to replace it) or you want to start on a big project (for example, you need to refurbish your shop).
What options are available?
Here is a non-exhaustive table of some of the most common types of business finance available.
Long terms – usually repaid in monthly instalments
Growing your business
Improving cash flow
How do I choose?
If it all looks very complicated, it’s not you, it’s them – business loans tend to be a bit of a headache. To make the choice easier, you can try thinking about the following:
Where your business cash flow issues come from. For example, do you experience cash flow problems because you own a B&B that mostly makes money in the summer? If that’s the case, borrowing money one-off probably won’t cut it – you’ll need a more permanent solution.
Your business credit profile. As usual, a good credit score and a long credit history will grant you access to better rates and less expensive borrowing options.
How your business makes money. Does your business make money through invoices, credit card takings or cash?
How long you need the money for. Cash-flow financing usually offers short-term credit.
How much you can afford to spend. Borrowing money comes at a cost, so you should always consider it as a liability and calculate whether you can afford it. Business credit cards are the exception. If they don’t charge an annual fee, you can borrow money for free – but only if you settle your debt in full every month.
What about a broker?
Finding a good deal on a business loan can take quite a lot of time, mostly because in most cases providers won’t tell you their interest rates before assessing your circumstances – so you may have to make a lot of pre-applications to get a full picture of the market.
A broker, or a matching service, can thus be a good idea – especially if you don’t have a big finance team and also need advice on the most suitable type of business finance. They’ll look at your business’s finances and needs and present you with a series of options. Many offer the service for free because they make money by charging the providers they host.
However, for that same reason, you do have to be aware that in most cases, they won’t be able to look at the whole market – they can only offer you a deal with the providers they have a partnership with.
Frequently asked questions
The short answer is that it depends on the business, and on what you need to do with your working capital. But at the very least, your working capital should be equal to zero – and that is, once you’ve already considered your own wage. If you want to grow the business, your working capital should definitely be a positive figure.
As we said, it isn’t a single type of loan. It refers to a series of business loan options that can help your business’s cash flow. Revolving credit options are often preferred when it comes to working capital finance because a cash-flow issue often has to do with the nature of the business itself and can’t be fixed with a one-off loan.
It usually does – you should definitely take it into account if you’re trying to establish whether you need to get a loan. However, when it comes to calculating it for investment purposes (that is, when calculating NWCInv, net working capital investment), cash is normally not included.
Valentina Cipriani is a writer at Finder UK. She writes news, features and guides about banking and credit cards, helping people to improve their financial lives. She holds an MA in International Journalism and loves taking complicated topics apart and giving them back to the readers in a clear and easy fashion.
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