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Working Capital Finance

Working capital is the fuel that drives your business, keeps it running smoothly and allows the potential to grow. Working capital refers to the funds available to cover day-to-day business expenses, an amount that is calculated by subtracting the business’s current liabilities from its current assets on the balance sheet. A working capital ratio (calculated as current assets over current liabilities) of 2:1 is considered desirable for a healthy business. A weaker ratio than this may mean that you’re having difficulty meeting commitments on a daily basis, and you may need support.

When the working capital available to you isn’t sufficient for these operational needs, it may be time to look for other sources of financing. An injection of cash may be needed to cover salary payments to employees, to pay suppliers on time or to pay other business debts, to increase personnel when orders or client demands call for it, to purchase stock, or just to sustain your business through a seasonal slowdown.

The purpose of working capital finance is to provide your business with short-term funding, to help you keep operational until your business has enough cash on hand to cover these expenses on an ongoing basis. This type of financing is not suitable for buying longer-term assets such as vehicles or machinery – the idea is to keep the business running smoothly, not to invest in large new assets, or purely for expansion.

Many types of businesses can have sales cycles with periods of high activity followed by slower periods, and it’s not unusual to need working capital finance to keep you going through these quieter times. Or it may be the case that your business is doing very well and having a busy period, but there are cash flow issues due to delayed payments – you still need help to bridge this gap in working capital.

Working capital finance gives you breathing room and helps you prepare for the next stage of your business journey.

How Does Working Capital Finance Work?

Generally speaking, and depending on the lender, this is an unsecured business loan, so your personal or business assets are not used as security.

Rates will vary between lenders and will sometimes be based on the degree of risk involved. It is a short-term loan, with terms typically ranging from 3 months to 2 years. The criteria for approving these loans can be stricter for banks and other traditional financial institutions. Alternative lenders often fill this gap and can act quickly to provide the funds that your business needs to keep things going.

Working Capital Finance Options

There is a range of different options for securing working capital finance, and you should consider which option is the best fit for your business type and needs.

The types of financing that may be available to you include the following:

  • If your business is experiencing a squeeze on working capital due to outstanding payments due to you, invoice financing (or invoice discounting) is a financing option that allows your business to draw money against the invoices that are owed to you, giving you access to cash from unpaid invoices.
  • An invoice is submitted to the Invoice factoring occurs when businesses sell outstanding invoices due to them to a third party, generally at 85-90% of what the invoice is worth..
  • With a line of credit, businesses can access funds as needed without additional fees. The credit amount is fixed; you can keep making repayments and keep drawing money again up to the agreed limit when you need it.
  • A merchant cash advance is a regular small loan that is an advance on your business’s future sales – the loan amount is received as a lump sum and repayments are made using a percentage of each sale.
  • Unsecured working capital loans allow your business to have access to funds without risking the loss of your personal or business assets. These loans are flexible, processed quickly, and often not dependent on projected future income or invoices due. They can be taken out alongside longer-term asset-based loans if needed.
  • A standard, traditional bank loan uses your personal or business assets as collateral. Interest rates on this type of loan are lower, as security is put up against the loan so less risk is involved for the lender.
  • SBA (Small Business Administration) loans are government-backed loans with low rates of interest that are used to cover daily expenses. To qualify, businesses must show that they have difficulty getting approval for traditional loans and they must also meet other SBA requirements

These options must be assessed on the basis of suitability for your business needs and your capacity to make the repayments involved.

Invoice Finance Options

There are two basic forms invoice, or debtor financing takes.

The factoring option involves the financier purchasing the invoice from the business. This means all payments by the customer are made to the financier, and the customer is fully aware of third-party involvement. This option takes all collection involvement out of the hands of the company borrowing money.

Discounting options involve a company borrowing a percentage against the invoice. The company still receives the payments from their customers, which they turn over to the financier towards the invoice. The customer may not be aware of third-party involvement in this arrangement.

Working Capital Finance Interest Rates and Fees

Interest rates may be applied in two different ways. The rate may be a more conventional fixed amount that is applied to the amount that you borrow, or it may be a rate calculated according to the risk assumed by the lender (risk-based pricing).

Qualifying Criteria

If you want to apply for working capital finance, there are a number of criteria that must be met, including the following:

  • You must have a business that is registered in Australia (ABN or ACN).
  • Minimum operating terms will be set by the lender.
  • The lender will specify turnover requirements.
  • Your business must have the capacity to make the agreed repayments in a timely manner.

How to Apply for Working Capital Finance

There is an easy application process for working capital finance that can generally be completed online. This financing option offers quick access to funds, which are sometimes available within one business day.

Generally, not too much paperwork is required. Lenders may request:

  • Financial information and documentation such as profit & loss statements, cash flow statements.
  • Identification documents for applicant.

Working Capital Tips and Considerations

Working capital finance helps your business to maintain productivity levels in tough times. It allows your business to be liquid, which has other advantages such as being in a position to negotiate cash discounts with suppliers.

Repayment terms are generally flexible as lenders are conscious of why this loan is needed in the first place. Loan terms can be determined according to your business circumstances, typically with a minimum of one month and a maximum of 18 months.

However, it’s important to keep the following points in mind:

  • Compare lenders to determine flexibility of repayment terms – some may penalise borrowers with late repayment fees, so make sure you are clear about this before proceeding.
  • Be aware of eligibility criteria such as the duration of your business activities and the level of your annual cash flow.
  • The funds borrowed must be used specifically for business expenses that you are currently unable to cover due to cash flow problems.
  • If your business is not doing well, this type of loan won’t fix it. Look into alternatives before you commit to taking on more debt.

Consider the following:

  • Does the lender offer flexible repayment options?
  • Should I apply for a secured or an unsecured loan? A secured loan will involve using personal or business assets to back the loan, while an unsecured loan will come with higher rates.
  • Are the rates too high? Because of the nature of this loan, generally involving smaller amounts and a shorter term, with broad eligibility and no obligation to provide collateral, lenders will generally charge higher rates to offset the risk factor. If this will cost your business too much, consider other options.

Capital Financing FAQs

  Is a working capital loan right for my business needs?

If your business is profitable on paper, but in reality meeting the daily operational costs is a struggle, a working capital loan may be right for you. The suitability of a working capital loan depends to some extent on the amount of funding that your business needs. Other financing options include credit cards, bank overdrafts, personal loans, or requesting discounts from suppliers.

  How much can I borrow? How much should I borrow?

The potential amount of the loan will vary depending on the lender. Loan amounts can sometimes go up to as much as $400,000. Carefully assess what your business needs and the degree of ease or difficulty of repaying larger loan amounts.

  What is the Term of the Loan?

The term for a working capital loan is generally between one and 18 months. The length of time will depend on the amount borrowed and the capacity of your business to make repayments within a particular time frame.

  How can I best manage this type of loan?

Prioritise your spending needs according to the degree of urgency and pay for the most pressing expenses first, such as electricity and telephone bills, rent, salaries, before using it for requirements such as purchasing stock or upgrading technology. Ensure that you maintain enough funds in your business account in the days leading up to the repayment date – choose strategic times for making larger purchases so that you don’t get into trouble.

Check whether the lender applies a prepayment penalty. If there are no fees attached to early repayment of the loan, this gives you the flexibility to clear it as soon as your cash flow situation allows without incurring any additional costs.

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