Outline
As a small business owner, you are going to need fast working capital at some point. In this article, you will learn:
Introduction
It would be nice if the cash flow provided by your business was 100% predictable, but alas, that isn’t the case. Your cash flow is inevitably going to ebb and flow, which means that you have to be prepared for when that happens.
You should think of your business working capital as insurance for your financial health. It is, in other words, a necessity.
What is Working Capital?
Your working capital is calculated by subtracting your current liabilities from your current assets. Your current assets are anything on your balance sheet that you should be able to turn into cash within one year, and your current liabilities are financial obligations that need to be settled within the same period of time. Here are a few current asset categories: cash and cash equivalents, accounts receivable, prepaid expenses, and inventory. Current liabilities include accounts payable, accrued expenses, notes payable, and taxes payable.
As a small business owner, you want to have positive working capital (current assets exceeding current liabilities, not negative working capital (current liabilities greater than current assets).
How much working capital do you need?
Your net-working capital is a deceptive measurement of your financial health because it doesn’t account for the size of your company. For example, $100,000 of working capital would likely be more than enough for a company with $30,000 of current liabilities, but it would probably be way too low for a company with $3.8 million in current liabilities.
So, your working capital ratio (current assets / current liabilities), is a better way to determine your financial health. The
ideal working capital ratio is usually between 1.5 and 2, but you may want to shoot for a number that is a little higher or lower depending on your
type of business and operating cycle.
Why You Might Need More Working Capital at Some Point
You might have enough working capital at the moment based on the attributes of your business. But again, your cash flow isn’t as regular as clockwork. And even if your cash flow is extremely steady, other things can happen that would eat into your working capital.
Here are some common scenarios that might put you in a pinch for working capital.
You Need to Replace a Long-Term Asset
Let’s say you have $20,000 in business working capital and your working capital ratio is 2. Seems like you have a strong working capital position, right?
But what if a business vehicle starts having serious mechanical problems? You want to buy a new one… and the cost is $50,000. You
might be able to finance the new vehicle without burning through all of your working capital, but it would be tight, and you would put your business in a precarious position.
Your Buyers are Late in Paying Their Invoices
As stated earlier, accounts receivable is one type of current asset. But here’s the thing: your customers aren’t always going to pay their invoices on time.
Consider a possible scenario:
You have $50,000 in current assets and $30,000 in current liabilities, which works out to a working capital ratio of 1.67. Of your $50,000 in current assets, three invoices add up to $30,000. These three customers have always paid their bills on time in the past, but there was an industry-wide slowdown, and they are unable to pay their invoices by the due date. Your company, however, has to make its monthly payments – or face stiff penalties – so you need an influx of cash.
You Want to Expand
Do you want to take your business to the next level? If so, you may need more working capital to finance your expansion.
Let’s say you have a service-based business with the following characteristics:
- You invoice your clients after you deliver the service.
- You usually have around $30,000 in working capital, and you feel like that has been just enough in the past.
- From start to finish, it takes around one month to deliver the service.
- You spend $5,000 to deliver the service to one client.
You were previously taking on around five clients per month, but you hope to increase that number to 12 clients per month. You would likely need to increase your net-working capital by at least $35,000 ((12-5) * $5,000) to meet the new demand.
You Have a Seasonal Business
If you have a seasonal business, like a pool maintenance company, your working capital needs will vary depending on the time of the year.
Let’s say your company services pools in Nassau County, on Long Island, and the average pool owner in the county keeps their pool open from Memorial Day until Labor Day. During your busy time, you may need to hire extra staff or pay for more equipment. In the off-season, you might still have to meet some short-term financial obligations. Your working capital needs are going to be different from May until September, compared to October until April – and they won’t always be predictable.
There is an Economic Downturn
We only have to look back to early 2020 to see a stock market crash, as the Dow went from
record highs to bear market territory in just one month. The rapid government response, and the PPP program, in particular, prevented a long and drawn-out recession, but there were still a lot of businesses that didn’t survive the coronavirus pandemic. In many cases, those companies didn’t have enough working capital to survive a period of lower sales.
A longer recession is going to happen sooner or later – a company’s access to working capital is a make-or-break factor in that situation.
How Do You Quickly Get Access to Working Capital?
Let’s look at a few working capital financing options:
Term Loan
A
term loan provides a borrower with upfront cash in exchange for monthly repayments based on a fixed or variable interest rate. The typical length of term loan can be between 1 and 25+ years, so they can be used to finance current assets like inventory or long-term assets like equipment.
There are a number of advantages with term loans including lower interest rates than other small business financing options, predictable monthly payments, and tax benefits. A term loan disadvantage is that there are minimum loan amounts – an issue if you only need a few thousand dollars. You’re also required to have a high credit score and a profitable history, which can be an issue for new entrepreneurs.
To get a term loan, you may need annual revenue of $250k or higher, a 660+ credit score, and at least 18 months in business.
Business Credit Card
A
business credit card may seem like a last resort for meeting working capital needs, as you obviously don’t want to accumulate credit card debt. But in certain situations, a business credit card can be a great way to get additional working capital.
For example, you have very short-term working capital needs because you are going to get an influx of cash in a week. In that case, you may be able to use a business credit card for working capital financing, and be able to pay it back without any interest payment.
Some business credit cards offer 0% APR introductory periods and cash bonuses. The right credit card, when used responsibly, can be a net benefit to your business.
The recommended credit score for many business credit cards is 670+, so small business owners with a lower credit score than that may have fewer options.
Business Line of Credit
A
business line of credit is essentially a combination of a
small business loan and a credit card. Here’s why it’s similar to a business loan: you get unsecured business financing that can be used for any business needs. It’s similar to a credit card because you only borrow what you need when you need it – and you only pay interest on the amounts borrowed. There is also a limit on the amount that can be borrowed – like with a credit card.
A business line of credit has a variable, not a fixed APR, which means that your monthly repayments may be higher than you expected at the time you applied for the line of credit. A few hundred
basis points may not sound like much, but in reality, it can result in a considerably higher monthly payment.
To qualify for a business line of credit, you typically need a credit score of 580 or higher, 12 months in business, and $10,000 in average monthly revenue.
How Do You Ensure That You Can Get Working Capital When You Need It?
Your working capital needs can change overnight, so you want to be fairly certain that you will be able to quickly secure working capital if that happens. You can start by looking at what it takes to get different types of working capital financing (credit score, revenue, history), and determine if your business meets the requirements.
But that’s only half the battle, as you also need to get your working capital
when you need it. In the digital age, you may be surprised to learn that many banks still take a long time to provide financing to small business owners, but that is still the reality.
Jyoti Sharma was presented with an
amazing business opportunity. But she needed fast funding to take advantage of it. She went to the banks and they told her they could give her a small business loan… but it would take 2-3 months. Sharma didn’t want to lose 2-3 months of income, so she went to Biz2Credit – she got a similar rate to what the banks were offering, but without the wait and with less paperwork.
Learn how Biz2Credit can provide
working capital financing for your business in 24 hours.
How to get instant access to financing
