Why founders need working capital to grow their businesses
We've all heard stories of companies running out of cash and having to close up shop. How is it that smart entrepreneurs with great business ideas become so unaware of the financial health of their business? It begs the question: “Can companies do a simple equation to see which direction their business is heading?” As important as it is to look at projected revenue, there is a better method for founders to understand the current financial health of their company.
Working capital is a company’s available cash that covers business expenses at any given time. It’s a company’s assets minus their liabilities. Assets include cash, accounts receivables (money owed from customers), property, and equipment costs. Expenses include short-term dues such as advertising costs, operational costs like utilities, payroll, and paying or owing debt.
When your expenses exceed the funds available to you, you can leverage your working capital to bridge the cash flow gaps for a temporary amount of time. This allows your business to continue operating as usual while avoiding any potential issues with stagnation in revenue and business growth.
How to calculate working capital:
What is gross working capital?
Gross working capital is the sum of the company's current assets. Assets include purchases that are convertible into cash within a year or less. Gross working capital includes cash, accounts receivable, and inventory.
What is net working capital?
The cash, capital, or funds inside your business account are all known as working capital. It is your gross working capital, minus your current liabilities. Net working capital is a measure of a company's financial health. It gives a dollar value to a business’s current capital ratio and is a measure to help manage operational costs and forecasting for growth activities like expanding, advertising, or developing new product lines.
What is the working capital cycle?
The working capital cycle is the amount of time, measured in days, needed to convert your assets and liabilities into cash. Cycle time will fluctuate based on your industry. For instance, in manufacturing, equipment tends to be expensive and is one of the factors that create a longer capital cycle. A shorter working capital cycle allows you to free up cash faster and be more agile with your business finances and spending abilities.
Working capital cycles involve the following four factors:
Cash – Ensuring there is a healthy cash balance by managing cash in- and out-flows.
Receivables – The payment terms for money owed on goods and services.
Inventory – How long it takes to sell your existing inventory.
Billing – How long you have to repay your suppliers.
How to calculate your working capital cycle:
What is positive working capital?
Positive working capital means your assets outweigh your liabilities and you have a surplus of funds to operate as normal. This differs from positive cash flow in that accounts receivable, or cash owed from customers that has not yet been paid, is considered an asset. In other words, cash flow is the money in your business account right now. It solely represents the liquid cash available to you and doesn’t include your business’s assets.
Example of positive working capital:
Let's say Joe's Coffee Roasters has $500,000 in current assets and $300,000 in liabilities. The online shop's working capital is $200,000. This represents working capital as a positive dollar value.
What is neutral working capital?
Neutral working capital means that the value of your assets and cost of your liabilities is the same. It’s considered a risky financial state because you don't have an excess of assets. If any emergencies were to occur, your assets can’t be liquidated quickly into cash.
What is negative working capital?
Negative working capital shows your liabilities outweigh your business assets and likely your day-to-day needs. All of your cash is likely tied up in operational costs and you don't immediately have funds to repay any outstanding debts.
What does a change in working capital signify?
Negative and positive working capital fluctuations occur in companies at any stage of business and remain a challenge for founders to this day. Changes in working capital can be influenced by operational business changes or market volatility.
A change in working capital can be caused by:
Production fluctuations: How long your products take to make or any bottlenecks within your production process.
Research and development (R&D): Investing in R&D to create new products and better understand your user needs.
Changes in payment policies: Changes in how your customers pay you or how you pay your operational costs. For example, switching your client invoices from monthly to annual payments for a discount. This can also include changes in credit from your suppliers.
Changes in operational expenses: Including increased utility costs, switching utility providers, changes in employee overhead, costs associated with moving an office, etc.
5 ways founders can manage working capital
Optimize your inventory
It’s no secret that inventory is expensive. Not only is the stock in your warehouse worth a large dollar value, unsold items can take up valuable shelf space. Having an understocked warehouse can lead to not meeting customer demands. Make it a priority to sell stocked items that are slow to move. Become more strategic with inventory management, and use formulas to help you predict stock outs before they occur.
2. Pay vendors on time
Maintain strong relationships with your vendors by paying bills on time. Failure to pay within the agreed-upon timeframes can result in late payment fees or interest charges. Keeping vendor relationships positive can allow you to renegotiate your payment terms and free up even more cash flow in your business.
3. Manage debtors
Without receiving customer payments, you won't be in business for long. By nature, some businesses have longer payment cycles than others. An option for companies with high-ticket purchase orders or products is to implement a Buy Now, Pay Later (BNPL) system or work out a payment plan structure with your buyers.
If you do have overdue payments from clients, contact the account holders to recoup outstanding payments. Another option is to work with a collections agency in order to receive payment or sell your overdue accounts.
4. Take payments online
If you don’t already have an online cart (point-of-sale), consider building one. Online payments are a much faster, more scalable way to access cash, and you no longer have to chase people for payments. Online payments show up online. This allows you to streamline your accounts receivables, and makes all of your accounting processes more streamlined, organized, and easier to track. Online payment data is also a great way to view key performance indicators (KPIs) directly tied to sales.
5. Get financing for your business
Look into alternative financing options to receive capital funding that will allow you to boost growth activities like advertising spend or purchasing more inventory. In many cases, looking for a loan can get you out of debt and increase your liabilities. Better options
like revenue-based financing (RBF) models allow you to leverage money from your future sales in order to scale today.
What problems does working capital funding solve?
Understanding your working capital means that you have a full bird’s-eye view of the financial health of your company today. Having excess capital allows you to operate and proceed with promotional activities that will allow you to scale your business without your dollars being tied up in operational debt and other business liabilities.
With positive working capital, you can:
- Increase sales
- Drive more website traffic
- Grow brand awareness
- Stock up in time for BFCM
- Keep your customers happy
- Free up cash for emergencies and marketing experiments
- Enter new markets
- Scale your team
- Invest in other activities that allow you to scale
How much working capital a startup needs depends on your business. If you are considering applying for capital funding, make sure to consider all moving factors including equipment costs, operational overhead, marketing, and inventory spend.
“It's amazing what you can do with $50,000. Even $10,000 goes a long way.”
Can you get capital funding with bad credit?
Contrary to popular belief, you can get business funding with poor credit. Here are a few options that entrepreneurs have used in order to grow their businesses, even with imperfect credit scores:
What type of capital funding is right for my business?
The right type of financial lending for you depends on the unique needs of your business, where it is in its life cycle, and what lending options you qualify for.
Consider these factors before applying:
- Do I need multiple funding solutions to meet the current (and future) needs of my business?
- Which funding options include flexible repayment options?
- What’s the credit impact of applying for this type of loan?
- Are there any prepayment penalties associated with this type of funding?
- When will I receive my funds? Is this a fast enough timeline to meet the demands of the business?
Each funding offer comes with a different set of terms. As with every financial decision you make, take the time to do your research and ensure that you're making the right decision for your business. Remember that access to working capital means your business will continue to operate smoothly without running out of money. Before you take your business to the next level, take a moment to make sure you've got enough working capital... and that it's working for you!
How can founders access Clearco working capital?
Clearco offers fast, flexible funding for founders of e-commerce, SaaS, and mobile app/game companies.
To apply for funding, simply:
- Connect your sales accounts. Our intelligent algorithms will analyze your sales data and look at the financial health of your business.
- Receive an offer in 48 hours (or less). After reviewing your business’s financials, we offer to buy your future sales today.
Accept funding to scale your business. You can use our working capital funding to scale your advertising efforts or fund your inventory so you can go to market and really WOW your customers!
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