One of the most difficult financial concepts to come to terms with is working capital. Many small-business owners struggle with understanding this term. In most cases, it means different things to different people, which makes the definition so complex. The specific definition for working capital states it is that amount of current assets over liabilities. This calculation can simply be run each period to figure out ways to go about analyzing working capital, but not much will be found as far as what needs are and how they can be met. There is a more useful way of going about working with this type of capital to make sure it serves a business best.
One of the Tools that can be Used
There is one tool that can be used in order to look at working capital. In many cases, people use operating cycles to carry out functions for looking over working capital. This cycle does the analysis for the business owner. It can give payable cycles in terms of days instead of weeks, as with which was done in the past. In this case, the analytics focus on the average number of days it takes for an account to be collected. The inventory is also taken into account as far as how long it takes for those items to be purchased both individually and as a group. In short, this tool looks at how fast products and services are purchased by consumers. It also tracks how long it takes for payments to be received. Therefore, looking at certain times of the month might indicate purchasing patterns for customers. With this information, a few things can be done. For example, the business might want to run a sale during that high peak of time in order to gain more purchases from regular customers. On the other hand, a sale can be done in the slow times of the month to attract people to purchase more often.
Finances Needed for This Situation
Most companies do not believe they can afford to pay for such cycles to be put in place. Accounts payable financing will not be able to handle this task on its own. Therefore, extra forces need to be purchased. Some businesses can afford this, but others cannot. Net profits that are generated from the process are what pay it off overtime, so if it can be afforded, than it should be introduced into the business as soon as possible. This project should be funded, even if it means taking out extra funds to do so.
Short-Term Working Capital
Short-term working capital is needed from time to time in order to enhance their operations. For example, take this situation for a retailer. They need to find working capital to fund extra purchases that are usually made between the beginning of the school year and Christmas. Therefore, they need to track how often inventory usually moves from the previous year in order to gauge what products needs to be purchased in the coming season for the sake of fulfilling upcoming demands by customers. Therefore, working capital needs to be in place in order to provide funding for these extra costs.
Short-term working capital, therefore, needs to be available for these situations when they apply. It can be difficult for small businesses to supply this capital during the first few years of operation. However, there are several sources of funding to pull from. In the best case scenario, a business owner needs to learn how to plan ahead for these expenses in order to start building up some working capital as soon as possible. This task limits the situations where a business owner might be caught off guard, which means they will not miss out on a big order if they play their cards right in the months beforehand. In order to find some extra funds, here are some financing options that can be pulled upon for working capital.
During the first year of operation, most businesses have not gained their profits as of yet. They need to have access to funds as much as possible. Usually, people go to the equity in their own homes or even that found in the home of a family member. This step is a little risky because it can mean someone might have to find other means of shelter and leaving if the business goes south permanently. In other words, it means the loss of a home for someone.
Some business owners thrive on the relationships they have made with their trade creditors. In some cases, small business owners can solicit the help of these trade creditors if they need help in providing working capital. A business owner simply needs to show evidence of where they have made payments on time in the past, and in most cases where this exists, trade collectors are willing to loan out the money to help with meeting the demands of a big order. In most cases, trade collectors are willing to pay on short-term loan terms, usually meaning when an order is fulfilled within a given timeframe. The usual timeframe happens to be 60 days.
There is another resource for short-term working capital called factoring. In this situation, a company buys the account receivable and handles the collection for the business. This mode costs some fees on the part of the business for going through a third party, but in restricted funding situations, it is a tactic that actually works.
Some people are able to go to banks and other lenders for a line of credit. If a business is new and capitalized perfectly well by equity but a good bit of collateral is available, then the business might qualify for a line of credit. These lines of credit are great for short-term funding when they arise. Once the accounts receivable has been paid on all inventory items, these lines of credit can be paid back with ease. In most cases, they can be made for one year at a time. However, the expectation is that they will generally pay up in 30 to 60 days.
Some smaller business owners just do not believe that working capital is for them. In reality, many small businesses thrive when they are able to pull on some working capital during the height of their busiest sales seasons. There are multiple ways to go about gaining working capital, and some of these avenues are also reliable for financial negotiations to take place. This occurrence works well for the business because it builds the business’s reputation when it comes to paying its bills.