Working capital is at the heart of every successful company, no matter the size, but for small businesses, it’s even more important that cash in the bank is monitored and managed carefully.
Understanding the importance of working capital and managing it effectively is also key to achieving better business returns and therefore increasing overall profitability. There are so many reasons for your business to pay close attention to working capital, and for many business owners, there will be times when you need to consider boosting your available funds with an additional source of financing.
- Every business should carefully manage working capital, and a loan can be a great option if you need a short-term boost quickly.
- Working Capital Loans vary, but a Capify Working Capital Loan offers more flexibility for businesses.
- There are many different ways you can use a Working Capital Loan, from managing cash flow to investing in new technology.
What is a Working Capital Loan?
Simply put, a Working Capital Loan is a type of business finance that can be used to fund your everyday business expenses such as staff wages, inventory or stock, and to help manage any cash flow gaps you might experience.
Unlike many other types of finance, a Working Capital Loan is designed to cover short-term operational needs. It is also often used to invest in or expand a business – whether that’s through exploring new markets, hiring new people or investing in updated technology – particularly when there is a need to progress things quickly.
Loans will vary between lenders, but at Capify our Working Capital Loan is paid back in small but regular amounts and you can choose whether you want that to be every day, Monday – Friday or every week. This way, business owners can avoid having to pay a large amount on a fixed date each month, giving them the flexibility to choose what works best for their business.
In essence, a Working Capital Loan is designed to ensure you can continue to pay your core operational costs, whilst giving you the flexibility to invest in your business if you have a specific need or an opportunity you want to make the most of.
How much working capital do I need?
Working capital is the minimum amount of available cash you need to keep your business running, day in and day out, including paying suppliers and employees, purchasing inventory or paying overheads.
Working out how much working capital you need is relatively simple.
First, you need to look at your current assets. This refers to any assets in your business that can be converted into cash within a year. This could be cash, investments, stock and inventory or accounts receivable. You should arrive at an overall number once these are all added up.
Once you’ve worked this out, you then subtract your current liabilities. Liabilities could include accounts payable, short-term debt, and notes payable, as well as income taxes owed. Anything that’s due within a year is a current liability.
The answer you get is referred to as the working capital .
Work out your Working Capital Cycle
The Working Capital Cycle for a business is the length of time it takes to convert the total net working capital (current assets less current liabilities) into cash. Companies typically try to manage this cycle by selling inventory quickly, collecting revenue from customers quickly, and paying bills slowly to optimise cash flow.
For most companies, the working capital cycle works as follows:
- The company purchases, on credit, materials to manufacture a product. For example, they have 90 days to pay for the raw materials (payable days).
- The company sells its inventory in 85 days, on average (inventory days).
- The company receives customer payment for the products sold in 20 days, on average (receivable days).
In the first step of the process, the company gets the materials it needs to produce inventory but doesn’t initially dispense any cash (purchased on credit under accounts payable). In 90 days’ time, it will have to pay for those materials.
Eighty-five (85) days after buying the materials, the finished goods are sold, but the company doesn’t receive cash immediately, as they are sold on credit (recorded under accounts receivable). Twenty (20) days after selling the goods, the company receives cash, and the working capital cycle is complete
Working Capital Cycle Formula
Based on the above steps, we can see that the working capital cycle formula is:
Inventory Days (85) + Receivable Days (20) – Receivable Days (90) = Working Capital Cycle (15)
This means the company is only out of pocket for 15 days before receiving full payment.
If you reach a point where your working capital drops or you want to grow your business but don’t have the working capital needed to do it, then you may need to consider alternative sources of finance, such as a loan.
What can you use a Working Capital Loan for?
There aren’t any rules about how you can spend a Working Capital Loan, however they’re commonly utilised to bridge financial gaps, for example during quiet periods, or to pay unexpected expenses.
Additionally, they can be used in situations where businesses experience seasonal peaks where they see high cash inflows, followed by periods of reduced revenue. The Christmas period is a great example of this – particularly for retail or e-commerce businesses.
On the other hand, the loans also offer a great opportunity to invest in growth, whilst still ensuring you can continue your day-to-day operations. Even growing companies can run out of cash because they need increasing amounts of working capital to support additional investment.
Here are five ways you could use your Working Capital Loan.
Managing business cash flow
Arguably, one of the most common uses of working capital finance is to boost cash flow. Cash flow management is a crucial part of any business, and according to Xero, a leading accountancy software firm, a huge 50,000 small businesses fail each year due to cash flow issues.
Working capital financing can help to cover operating finances during these periods of poor cash flow, whether that’s to pay staff, keep your premises running, or even to cover your rent or mortgage payments.
Tip: Preparing a cash flow forecast is a good way to identify potential issues before they happen and can help you grow your business.
Supplement seasonal shortfalls
Seasonal businesses come with a unique set of challenges, including how to fund new stock and employ short-term workers ahead of a busy period, whilst trying to keep on top of everyday costs during quiet periods.
Working Capital Loans offer the perfect lifeline for these circumstances and allow businesses to not only operate during quiet periods but also to plan for peak seasons.
Update equipment or technology
There are times in every business where you’ll need to make investments to upgrade or replace equipment and technology. However, acquiring new equipment can be costly, and short-term financing can provide the funds needed to invest without impacting your current cash flow.
Marketing your business
Every business owner will understand the importance of investing in marketing, but it’s often hard to justify the cost without knowing what revenue it will drive. A Working Capital Loan can be used to cover the return-on-investment opportunities that a marketing campaign can create.
A well-executed marketing campaign can help your business reach new audiences, increase awareness of your brand and as a result can boost your revenue. There are no set rules on how much you should spend on marketing for your small business, with different surveys putting the figures as being between 7.5% and 15%.
The key thing is to look back at your growth in the previous year and match that to your marketing spend. If you’re looking to grow twice as much this year, you may need to consider doubling your marketing budget.
Hiring or training staff
Have you ever experienced a period where your business requires more staff in order to grow but you don’t currently have the funds to pay more wages? It’s a common challenge for businesses and especially for SMEs, but with some additional financing, you could take the next step and move your business to the next level.
Getting the right team in place to help you hit your growth targets is vital for any business, so it’s worth investing in the right people to help you get there.
Bridge payment delays
Delayed payments can happen in business, and the knock-on effect on working capital can be significant. A working capital loan will provide you with the funds needed to plug that cash gap.
The government announced earlier this year that it wanted to crack down on late payments with reforms to the Prompt Payment Code. It revealed that the 60-day target required for 95% of invoices was still being missed repeatedly and that £23.4 billion worth of late invoices are owed to firms across Britain, impacting on cash flow and ultimately their survival.
These five suggestions are just some of the ways we’ve seen the small businesses we help use a Working Capital Loan, so your finance is definitely not limited to this. At Capify, we’ve worked with SMEs for over a decade, which means we understand some of the challenges small businesses face when it comes to finance and some of the fantastic benefits a Working Capital Loan can bring.
If you want to find out how much you could borrow, you can check your eligibility for a small business loan in just 60 seconds or if you want to find out more, then our team are on hand to answer any questions you may have.