Our nation is home to about 23 million small businesses, and they employ more than half of the American workforce. Though each is somehow different from the others, what many do have in common is a need for financial assistance in some way. About 16% of all loans taken out in the U.S. are for business use only, though they’re taken out for a variety of reasons. A third of American small businesses cite “unpredictable business conditions” as their motivation for taking out a small business loan, and nearly a quarter blame poor or slow sales. Still another 63% pursue business loans as cash flow solutions. It is this last portion that we’re going to focus on today.
Working capital is one of the most difficult concepts for new small business owners to understand, and many are a little too quick to apply for business working capital loans. Here, we’ll provide a few suggestions about determining your true working capital needs and a few common sources of business working capital.
How Much Business Working Capital Do You Need?
By definition, working capital is simply the amount by which your current assets exceed your current liabilities. Far too many businesses leave their calculations there, and can’t quite figure out why they never seem to have as much as they should. A more useful way to determine working capital needs is by looking at your operating cycle. Analyze your accounts receivable, inventory, and accounts payable cycles in terms of days.
- Accounts receivable should by analyzed according to the average number of days it takes to collect.
- Inventory should be analyzed in terms of the average number of days it takes to turn over the sale of a product (from arrival at your door to conversion to cash or accounts receivable).
- Accounts payable should be analyzed by the average number of days it takes to pay a supplier inventory.
Where Can Business Working Capital Come From?
You have more options than you might realize. Here are the five most common working capital sources:
- Equity. Businesses in their first few years often have to rely on equity funds for short term working capital. They might come from personal resources, family members, friends, or investors.
- Trade creditors. As long as your relationship with your trade creditors is very good, you might be able to approach them for help with short term working capital. For example, they might extend terms to help you meet a big order.
- Factoring. In this model, a factoring company buys your accounts receivable and handles the collection, keeping a percentage of the payments in exchange for cash up front.
- Credit lines. These aren’t usually extended to new businesses, but they can allow companies to borrow funds for short term needs.
- Short term loans. Loans with terms of less than a year are frequently used to finance temporary working capital needs.
The first step toward maintaining adequate working capital is to determine how much you need. Once you have a better concept of what your business really requires, evaluate your options for acquiring it. You won’t make it far without the working capital you need. Research more like this.