As your business grows, so do your responsibilities. If the daily operations increase by a sizeable amount, without the right funds, it might be hard to keep up. In such situations, working capital financing can come handy. A working capital loan helps you in running your day-to-day operations. These loans are typically used to cover recurrent expenses such as accounts payable, wages, and so on. If you are considering getting a working capital loan for your small business, it would be best to understand what a working capital is in the first place.
Understanding Working Capital
Simply put, working capital is the money used to run the day-to-day business operations. You can simply calculate your working capital by subtracting current liabilities from current assets. This money can be used to pay for all sorts of things such as rent, payrolls, and stock up on inventory. Various banks and NBFCs provide working capital financing to businesses. Not all businesses have consistent sales or revenue throughout the year, and the need for money to keep operations running may arise at times. This is typically the case for businesses with seasonal business cycles or cyclical sales, while others may require such a loan during holiday seasons or periods of low commercial activity. Such loans can be secured or unsecured, which means you may or may not be asked to pledge security to obtain the loan, depending on the loan amount and the financial condition of the business. Working capital reflects a company's financial health and liquidity situation.
It is best advised that businesses make the most of their working capital. Let’s take a look at some ways to maximise the financing you’ve just received.
Whether you acquire your working capital loan from a traditional bank or an alternative lender, you must proceed with caution. Make a clear plan for how you will use the working capital financing you receive, including cash flow estimates that demonstrate how the capital will benefit your business. Just because you have financing doesn't mean you're out of the woods: if your business doesn't create enough cash flow, you may soon find yourself in another liquidity crunch. An intensive plan helps you to understand the areas where you need a little push. It’ll further help you to focus on the places where your business is lacking and allow you to make up for it.
Borrow What You Need
Borrowing more than what's required can at times prove counterproductive. That's because borrowing more than you need causes two problems. For starters, your repayment amount will be significantly greater than it has to be. This may not be an issue right now, but it could become one in a few months if your cash flow slows down. Secondly, unless you have effectively used your working capital business loan (e.g., by purchasing equipment, hiring additional staff, expanding, etc.), the extra funds will most likely be "dead money" lying in your bank account. Today, however, business savings accounts pay little to no interest — and what they do pay is below the rate of inflation. As a result, by retaining it in your bank account, you will be losing money.
Maintaining Cash Flow
All business comes with its share of ups and downs. However, in order for a business to prosper in either environment, working capital is necessary. Maintaining a consistent flow of liquidity ensures that businesses are viable and can satisfy basic demands such as holding sufficient inventory, paying employees, rent, utilities, and mortgage payments as scheduled. It also allows for any surplus money to be re-invested in growing the firm. By obtaining a consistently high level of working capital, organisations ensure that sufficient cash levels are available for any potential upcoming prospects or unforeseen scenarios. It also provides businesses with greater flexibility in how they conduct their operations, allowing them to fulfil client orders, expand, and invest in new goods more quickly. Working capital financing provides entrepreneurs with continuous access to capital and aids in the optimisation of cash flows while investing in the company's growth.
Capitalising Seasonal Swings
Several businesses are cyclical, meaning that business can double or triple in certain months, such as holiday seasons or summers. While businesses are eager to capitalise on seasonal upswings, they are constantly concerned about a severe working capital crunch, which prevents them from accepting larger orders. Working capital financing is a great way to bridge this gap and allow businesses to utilise the rise in demand without adding stress to the finances.
Maintaining a healthy working capital reserve will support you in running day-to-day operations efficiently. Access to sufficient working capital also provides opportunities to build and scale a business to its full potential. Working capital loans for small businesses are a great resource for those who want to grow and expand their business. By keeping in mind the above-mentioned ways, you will be able to make the best use of the working capital financing you receive.