Working Capital Loan
First and foremost, it is important to understand what working capital loans are for. These types of business loans are specifically for funding daily operations of a business. It is taken to finance a company's short-term operational needs and not used to buy long-term assets or investments. Some of the operational needs include costs such as payroll, rent and debt payments.
Companies that have high seasonality or cyclical sales usually rely on working capital loans to help with periods of reduced business activity.
Let's talk benefits
Does not require equity transaction
Debt financial and does not require an equity transaction; business owner remain to have full control of the company.
Easy to obtain
Easy to obtain and lets business owners efficiently cover any gaps in working capital expenditures.
Working capital is the difference between your current assets and current liabilities and is used to cover everyday business expenses. Working capital is important because it is used to measure how much money you have left to run your business after deducting expenses, paying your vendors, etc.
Current Assets: Short-terms assets such as cash, accounts receivables or any assets that will become cash by the end of the financial year
Current Liabilities: Debts owed by a business that must be paid in the next twelve months, such as short-term loans and accounts payable.
To determine your business’s working capital, use this equation:
Current Assets – Current Liabilities = Working Capital
How Much Working Capital Does Your Business Need?
If you are considering a working capital loan, you will probably be asking yourself and how much working capital does my business need? Ideally, you want enough working capital to cover your business expenses and pay your debts, but you also want to be using your assets to further invest in your business.
The Working Capital Ratio
The working capital equation helps businesses find the sweet spot between paying existing debts and expenses while preparing for future business growth. This equation can also help you figure out how much you should borrow in a working capital loan. One way to gauge your business’s efficiency and financial health is by using the working capital ratio. Here is the working capital formula:
Working Capital Ratio =
Current Assets / Current Liabilities
If a company has $10,000 in current assets and $8,000 in current liabilities: 10,000 / 8,000 = 1.25, then the working capital ratio is 1.25.
Generally, a working capital ratio of < 1 is taken as indicative of potential future liquidity problems, while a ratio of 1.5 to 2 is interpreted as indicating a company on solid financial ground in terms of liquidity.
A substantially higher ratio or a ratio > 2 can indicate that a company is not doing a good job of employing its assets to generate maximum possible revenue. A disproportionately high working capital ratio is reflected in an unfavourable return of assets ratio, one of the primary profitability ratios used to evaluate companies.
What Does the Working Capital Ratio Indicate About Liquidity?
In any event if a company cannot meet its financial obligations, then it may face the danger of closing, no matter how rosy its prospects for future growth may be. One need However, one need to understand that working capital ratio is not a truly accurate indication of a company's liquidity position. It simply shows the net result of total liquidation of assets to satisfy liabilities, an event that rarely actually occurs in the business world. It does not reflect additional accessible financing a company may have available, such as existing unused lines of credit.
Traditionally, companies do not apply loans for more cash on hand than necessary as doing so would incur unnecessary interest costs. However, operating on such a basis may cause the working capital ratio to appear abnormally low.
Nonetheless, comparisons of working capital levels over time can at least serve as potential early warning indicators that a company may have problems in terms of timely collection from their debtors, if the company has difficulty collecting the debt, it could lead to liquidity crisis in future.
The Difference between a Working Capital Loan and a Traditional Business Loan
Traditional type of business loans help business pay for specific physical assets, lie cars or equipment. For some businesses, they consolidate all the smaller loans into one loan for easy management and get to enjoy lower interest rate.
Working capital loan does not restrict the usage of the funds, businesses can than use the funds to cover rental, electricity &/or phone bills.
Why do you need
Working Capital for Business
In a perfect world, working capital comes from the cash flow generated from your sales of your service or product.
However, not all businesses enjoy a smooth cash flow, ie the inflow of cash may not be timely for one to pay your creditors, staff, etc. Or you may be operating a seasonal basis and need cash during your off-peak season. If you cannot keep up with your daily expenses each month that are due, you may have to close your company even if it is generating profit.
It is important to understand that even some businesses that show a profit on paper can struggle to meet their daily expenses. If you have been scrambling to find the funds to pay your regular bills (maybe even taking expensive credit card cash advances) then a working capital loan could be the right option for you.
If you need a working capital loan, do get in touch with BizBridge for a free consultation and you can have the funds for your business soon.