Working capital is the figure calculated by subtracting the current amount of liabilities your company has with the current assets available. Liabilities, in this case, include any items you’re spending money on, where assets refer to cash in the bank.
Working capital allows the business to continue functioning between receiving payments and buying new product. As such, it isn’t uncommon for a business to find itself needing a bit of extra working capital to hold them over until the net profits are available from previous accounts. Luckily, there are several common methods that can finance working capital for a business. Let’s discuss these briefly.
These loans are typically going to be under a year, and ideally a company will pay this short-term loan back as soon as possible. While many new businesses may find it hard to get a short-term loan, those businesses with a good reputation at their bank and a long banking history may find this isn’t as difficult as trying other methods.
A line of credit will generally require a purpose, such as a short-term increase in sales that requires additional funds to accommodate until payments are made, and are typically allotted for a single year, but often expected to be paid back much sooner.
For many businesses, if you’ve been a great partner and always paid on time, many traders will willingly increase the amount of time you have to pay off your debts to them, allowing you some free capital and the product needed to take advantage of the short-term increase in business you’re experiencing.
This method for gaining some working capital is only ideal if you are likely to sell the product within that timeframe and have no issue paying them within the time limit.
Equity refers to any amount of money available from outside resources, often those of the business owner, a family member, friend, or an investor. This equity is pumped into the business to accommodate for the short-term need of working capital, and then paid back as soon as possible or as per the terms. When borrowing equity from a family member or friend, make sure to work the terms out just like you would any other business deal. Having it on paper makes it easy for everyone to know what to expect.
Watch our video about The 4 Most Common Types of Working Capital Financing: