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What is Working Capital? A Breakdown of What You Need to Know

Working Capital Loan

What is Working Capital? A Breakdown of What You Need to Know

Updated: December 1st, 2020

What is working capital? A breakdown of what you need to know

While small business owners may be well versed in cash flow, there is another metric – known as working capital – that digs even deeper into the health of the balance sheet. And while cash might be king, working capital is what will likely determine the extent to which your business can grow. Let’s take a look at what working capital is and how it could play into your financing needs as a small business owner. 

Working capital for small businesses 

By definition, working capital for small businesses is a business owner’s current assets (what they own) minus current liabilities (what they owe). A positive sum generally suggests that the business is healthy and will be able to pay its short-term liabilities. A negative result suggests that the business may have trouble making those payments. 

More broadly, working capital is a reflection of how quickly and efficiently a business owner can access the funds to support day-to-day operations. Put another way, working capital is the money that you use to pay for day-to-day expenses. These might include the electric bill, vendors/suppliers, hiring talent, payroll, and rent. 

The balance sheet lines comprising assets might include:

  • Cash
  • Marketable securities
  • Accounts receivable
  • Inventories 

Balance sheet lines comprising liabilities could include: 

  • Accounts payable
  • Accrued expenses 
  • Notes payable
  • Long-term debt 

When cash flow is tight in the near-term, a business runs the risk of going under even if its long-term profitability plan is intact. A working capital loan gives business owners the opportunity to access financing to cover these expenses. 

Working capital small business financing 

Working capital small business financing is designed to help business owners cover short-term expenses, rather than long-term needs such as making investments or purchasing assets. The financing could be directed toward a number of short-term expenses. These could include covering payroll, buying supplies/inventory, equipment financing, or just to fill the gaps in daily cash flow. 

There are different types of financing that belong under the working capital umbrella. These include term loans, lines of credit, and even invoice factoring. Let’s dig a bit deeper into the various types of working capital financing. 

  • A working capital small business loan will typically have a fixed interest rate or factor rate attached to a repayment period. It is short term in nature and thereby will have short repayment terms, which at Funding Circle could be anywhere between six to 18 months. These loans are typically unsecured in nature and most times won’t require collateral, which is a perk. You may still need to provide a personal guarantee of some sort, which will cover the amount of the loan in the event of a default. 
  • A working capital credit line is a business line of credit for short-term needs and can be helpful for seasonal businesses that experience ebbs and flows in cash flow. The terms vary by lender but credit lines could range from $1,000-$250,000. You draw from the credit line as needed, and are only responsible for repaying what you use over a set period of time plus daily or monthly interest. Repayment terms are between six and 24 months.
  • Invoice factoring is another type of working capital financing. In this case, a business owner exchanges their unpaid invoices for a cash advance. As a result, the business owner doesn’t have to wait the typical 30, 60 or even 90 days it takes for customers to pay invoices. Invoice factoring companies charge business owners a factor rate of between 1-5% for the cash advance and there could be additional fees as well.   

The current economic environment may require business adaptability. Working capital financing is considered one of the easier ways to access financing. If you are a startup and haven’t yet established a couple of years of operating history under your belt, don’t have the collateral that’s required with other types of loans, or are just experiencing a cash crunch, working capital financing could be the solution. 

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