Learn what working capital financing is, its advantages and the different approaches to managing it
Capital is the lifeblood of any company. When it comes to selecting the best type of financing, there are many factors that a business needs to consider. One of the more popular forms of financing is working capital financing. This begs the question, what are the ways to manage working capital financing?
What is working capital financing?
Working capital financing is when a company borrows money to pay for ongoing operations and payroll rather than investing in equipment. Working capital financing is a frequent source of funding for companies having erratic cash flows.
In this blog post, you will learn:
- What businesses can benefit from working capital financing?
- What roles does working capital financing play for businesses?
- What are the advantages of working capital financing?
- What are the approaches to managing your working capital financing needs?
What is the ideal business for working capital financing?
Working capital financing is a tool used by businesses in every sector to grow and scale.
A large company with stable cash flows might seek working capital financing to fund expansion into a new market. In this case, funding will serve as a stop-gap measure until the new market is self-sufficient.
For many smaller companies, working capital financing is used to close the gap between cash inflows and inflows. While working capital financing can benefit every company facing a working capital shortfall, it is can mean the difference between life and death for cyclical, or seasonal companies such as tourism and farming businesses.
What role does working capital funding play for businesses?
Whether a company is experiencing cash flow problems, or just looking to keep extra cash on hand, businesses of all sizes use working capital financing to close cash flow gaps. Additionally, it is a good business practice keep a given amount of cash on hand for unexpected events. Companies will often use working capital financing as a financial cushion, should the need for extra cash arise.
What are the advantages of working capital financing?
There are many advantages to a business from using working capital financing. Some advantages include:
No collateral needed
Companies with a strong credit rating can access working capital financing without putting up collateral. In the case of default, they are not required to give up any collateralized assets. A business’s credibility is increased by having access to zero collateralized finance.
Fill in Budget Gaps
Working capital financing can increase the long-term viability of a business by covering payment gaps when payables are greater than receivables. Small and developing companies can use working capital financing, in combination with accounts payable to fund working capital.
Faster and more flexible
Companies can access working capital financing much faster than a traditional bank loan. Lending institutions such as Zip Capital Group must act swiftly because companies needing working capital financing often have urgent cash flow needs. Businesses can have a decision regarding financing in minutes with funding in a day.
The factors driving our working capital financing program includes:
- The importance of providing swift financing.
- Flexible repayment terms
- A risk assessment considering the client’s business style, sector, and prevailing interest rates.
- The applicant’s turnover ratio,
The working capital turnover ratio reveals how effectively the company meets its immediate obligations. It also demonstrates how much money for working capital it will require going forward. If a company lacks the cash flow to make regular payments, working capital financing is not a good option.
What are three approaches to financing your working capital needs?
Just as there are strategies to manage your cash flow, there are strategies to manage your working capital financing. The ideal strategy for managing your working capital financing will depend upon your circumstances, particularly your industry, size, turnover ratio, and financial objectives.
The three approaches to manage your working capital financing include:
- A conservative approach
- An aggressive approach
- A hedging approach
The differences in approaches have to do with the source of funds for working capital.
A conservative approach
As the name implies, this tactic finances working capital with little risk. In these situations, working capital financing will mostly be obtained from long-term financing solutions, such as term loans, equity financing, and debentures. Some of this financing can also fund short-term capital needs.
Since funding is from long-term sources of capital, financing is impervious to the risk of interest rate fluctuations and is hence low risk.
A conservative approach may be used by seasonal businesses with substantial cyclical cash flow fluctuations, such as those businesses in the tourism or farming industries. A conservative approach to working capital financing serves as a risk-mitigation measure against insolvency.
An aggressive approach
On the other hand, makes use of long-term funds to finance long-term assets and a portion of permanent working capital. The remaining portion of permanent working capital and temporary working capital needs are financed through short-term funding sources.
The increased risk of an aggressive strategy lies in short-term funding source exposure to interest rate risk and market trends.
In exchange for an increased risk exposure, an aggressive approach to working capital financing offers increased profitability as a result of the lower funding cost of short-term capital.
A hedging approach
A hedging approach, or maturity matching funds approach to working capital financing matches long-term requirements with long-term funding sources and short-term requirements with short-term funding sources. The underlying principle is each funding requirement should be financed with a funding source having the same maturity.
Which approach to managing your working capital is best for you?
The best approach to managing your working capital is going to depend upon your circumstance, the industry you are in, your size, turnover ratio, and your financial objectives. It may also depend upon the cyclicality, or seasonality of your business.
Regardless of which approach you take, how you manage your cash flow is directly proportional to the long-term viability of your company. As a result, it is something you must take seriously.
Zip Capital Group is an entrepreneurial company specializing in the small business funding for entrepreneurial organizations. We specialize in such funding vehicles as working capital financing, the Merchant Cash Advance, and equipment financing.
Contact us or call us today at (800) 795-3919 to discuss your working capital financing needs today.