Working capital refers to the amount of available cash on hand that allows you to smoothly run the day to day operations of your business. Essentially, when your income exceeds your expenses, there is excess cash available for you to use.
Every small business needs working capital to function properly. Whether you are paying staff, rent, bills, upgrading or repairing equipment, there is always a need for an ample amount of working capital. A smart business owner knows how to properly maintain adequate working capital, whether that be by borrowing money or keeping reserves of cash in the company.
In this article, we are going to discuss two categories of working capital, the need for working capital, and the different forms of working capital available for your small business.
Two Categories of Working Capital
There are two categories of working capital that you should consider when planning finances and allocating money for your small business. First, there is capital to cover day-to-day costs and maintain operations. This first category covers anything that might come up in a normal business day that requires money to fix.
The second category of working capital to consider is long-term cash. This second type of capital includes planning for long-term projects and new business plans. Every small business owner should be thinking about what is next, and you will definitively need a reserve of cash to put those plans into action.
Every Business Needs Working Capital
By understanding working capital and the needs for your small business, you will be on top of your financial plans. A strong working capital strategy includes proper planning. By keeping track of working capital through the ups and downs of different business cycles, you will never be caught off guard.
Every business market has different cycles, where money flows in and out at different times. By understanding the market you are in, you can set up an organized working capital plan. When you arrive at the place where you can predict your working capital needs, the odds of running short will be virtually eliminated.
It’s fact that your small business needs enough working capital to meet all of your financial obligations while being prepared for change. If you run out of funds, you’ll need to know where to find working capital in order for you to sustain your business.
Different Forms of Working Capital for Your Small Business
When you need working capital for your small business, there are multiple sources to consider. Like with any financial underwriting, your personal and business credit history will play a key factor in your qualification for different options.
The first two kinds of working capital are from the Small Business Administration (SBA), a government agency that supports small business owners and entrepreneurs. The SBA offers long-term and short-term loans to small business owners.
The next two forms of working capital are different types of credit lines, which are business lines of credit and trade credit. A business line of credit works like a credit card. The lender and borrower agree on an amount, the interest rates, and the terms, and there are not many restrictions on purchases. Trade credit is similar, where a small business can buy goods or services from different parties without making immediate payment.
The next three forms of working capital are different forms of financing for small business owners. Accounts receivable financing, or factoring, refers to a process of selling your invoices to a factor company for immediate cash. The factoring company gives you the money to use instantly, after which your client pays the factoring company the invoiced amount on the due date.
Inventory financing involves using inventory as collateral in order to receive a line of credit to purchase additional inventory. Lastly, equipment financing includes equipment loans and or equipment leasing. Equipment financing involves paying for equipment over time rather than up front, which by-the-way comes with numerous tax benefits.
Another option for working capital is a business credit card. A business credit card is just a line of credit for your business, attached to a credit card. A business credit card is basically the same as a consumer credit card, with the only difference being it is used exclusively for business expenses.
The last two forms of working capital available for your small business are cash advances. There are merchant cash advances as well as advances from customers. A merchant cash advance is a type of financing based on your future business spending. In exchange for immediate cash, you pay the lender back a percentage of your future sales. Similarly, advances from customers are early payment for future goods or services.