The working capital is one of the most difficult financial concepts to understand for the owner of a small business. In fact, the term means many different things to many different people. By definition, working capital is the amount by which current assets exceed current liabilities. However, if you simply run this calculating each period to try to analyze working capital will not really come to find out what their capital needs and how to meet them .
A more useful tool for determining their working capital needs is the operating cycle. The duty cycle analyzes account receivable, inventories and account for cycles in terms of days. In other words, accounts receivable are analyzed by the average number of days it takes to collect an account. The inventory was analyzed by the average number of days it takes to deliver the sale of a product (from the point where it comes in the door to the point that it becomes cash or an account receivable). Accounts payable are analyzed by the average number of days it takes to pay a supplier invoice.
Most companies can not finance the work cycle (days accounts receivable + inventory days) only funded accounts payable. This deficit is usually covered by net profit generated internally or externally by borrowed funds or a combination of the two.
Most businesses need a short – term working capital at some point in their operations. For example, retailers must find working capital to finance inventory accumulation season between September and November to Christmas sales. But even a business other than occasionally experiences seasonal peak months when orders are unusually high. This creates a need for working capital to finance inventory and the resulting accumulation of accounts receivable.
Some small businesses have enough money to finance capital reserves of seasonal work . However, this is very rare for a new business. If your new company experiences a short – term need for working capital during its first years of operation, you will have several possible sources of funding. The important thing is to plan ahead. If you get caught off guard, it is possible that the large order which could put your business with a hump miss.
Here is the five most common sources of funding short – term working capital:
- Equity . If your business is in its first year of operation and has yet to become profitable, then you might have to rely on capital funds short term, working capital needs. These funds could be injected their own personal resources or a family member, friend or an outside investor.
- Trade creditors . If you have a particularly good relationship established with its commercial creditors, you may request your assistance in providing short – term working capital. If you have paid on time in the past, a commercial creditor may be willing to extend the deadlines so you can meet a big order.
- Factoring . Factoring is another resource for short – term financing of working capital. Once you have filled an order, a factoring company buys your accounts receivable and then handles the collection. This type of financing is more expensive than conventional bank financing but is often used by new businesses.
- Credit line . The credit lines are not often given by banks for new business. However, if your new business is well capitalized by equity and has a good warranty, your business may qualify for one. A line of credit allows you to borrow short – term funds needs that may arise. The funds are paid once to collect accounts receivable that resulted from short – term peak sales. Credit lines usually are made for one year at a time and are expected to be paid for 30 to 60 consecutive days sometime during the year to ensure that the funds are used for short – term needs only.
- Short – term loans . While your new business can not qualify for a credit line from a bank, you can succeed in obtaining a short – term loan (less than a year) to finance their capital needs temporary work. If you have established a banking relationship with a good banker, he or she might be willing to submit a short – term note for a weekend or for a seasonal inventory and / or accumulation of accounts receivable