Essential ways to fund your working capital
Working capital is the amount available after deducting a company’s current liabilities from its current assets. Generally, working capital is expressed in terms of ratio. A 1.2 or 2.0 ratio indicates that a company is healthy and performing accordingly.
A lower ratio means that the firm has more current liabilities than current assets. This situation can lead to the company facing problems to deal with its regular expenses.
In such cases, businesses opt for working capital finance available through internal and external sources.
Learning about the classification of working capital is essential before knowing the sources of financing.
Classification of working capital
Working capital falls into two categories:
1.Operating cycle view
a.Fixed capital: It refers to a long-term asset that bought for income generation purposes. Fixed capital is not convertible into cash.
b.Net working capital: It is the difference between current liabilities and assets.
c.Gross working capital: Another name of current asset is gross working capital. Unlike fixed capital, these are convertible into cash.
2.Balance sheet view
a.Temporary: Temporary working capital is the amount available after subtracting permanent working capital from net working capital.
b.Permanent: Permanent or fixed working capital is the minimum amount required to run a firm.
Sources of working capital finance
Let’s first list down sources to finance short-term working capital.
●Short-term loan: A short-term business loan is one of the most widely availed sources of financing. These loans are quickly available within 24 hours.
●Equity: Equity funds can be called another way to meet the working capital needs of a small or start-up business. Third-party investors or personal resources are the top sources of equity.
●Line of credit: New firms are not liable to enjoy the benefit of a line of credit. For those who held good collateral can get qualified for a line of credit. As per this type of financing medium, borrowers are required to pay off the loan amount within 30 to 60 days. Calculating working capital requirements is crucial before opting for a line of credit.
●Trade creditors: Creditors can help your business in case all your past payments were paid well on time. Suppose a company received a large order, which is to be fulfilled within 60 days. In such cases, this short-term financing can be of help from creditors.
The main difference that lies between long-term and short-term working capital is the interest rate and tenor. Borrowers can avail low-interest rates on the following long-term working capital finance.
●Public deposits: As the name suggests, this category of deposits are funded directly by the public to business organisations. It is a great method that existed before the external funding came into the picture.
●Ploughing back profits: This is perhaps the most viable source to finance working capital because it guarantees a stable dividend policy. The reason why businesses opt for this category of financing is that it eliminates the requirement for securities.
●Debenture: Debentures are long-term loans with a fixed rate of interest that are payable on a specified date. The interest paid on debentures is tax-deductible, making them one of the ideal sources of long-term financing.
●Secured loans: Secured loans are long-term and come with lower interest rates than unsecured ones. However, borrowers have to mortgage an asset to avail these loans. Knowing about the businessman’s guide to working capital loans can help firms understand more about these financing options.
These sources of working capital finance help businesses secure funds depending on needs. Opting for funding at the right time can aid companies to improve their working capital turnover ratio.