Working capital is defined as current liabilities subtracted from current assets- aka, the current assets remaining after debts are taken into account. According to an Entrepreneur article called How to Determine Your Working Capital Needs, though, calculating what it means to your business is a little more complicated. They recommend using the operating cycle, or the time is takes for a sale to be paid. When companies have credit terms, this can be anywhere from 30-90 days and sometimes even longer when customers do not pay on time.
Financing the company in the interim can be a challenge, and most small businesses don’t have enough excess funds to do so. There are several options for getting short-term working capital, including but not limited to the following:
In this form of financing, a factoring company buys their client’s accounts receivable and advances 80-90% of the value up front. When the remainder is paid, they give back the rest less an agreed upon fee. Advantages of factoring are flexibility, speed of delivery, and reduced overhead by outsourcing the collections process. The main disadvantage is that it is relatively expensive compared to bank loans.
Line of credit
If the business is well financed and has good collateral, they may qualify for a line of credit that allows them to borrow funds when needed. The money must be repaid to the bank once the accounts receivable are paid in full. Advantages to having a line of credit are financing when you need it and that it is relatively cheap. A major disadvantage is that they have strict policies and not many small businesses qualify.
Short-term bank loan
For businesses that don’t quite qualify for a line of credit, it might be possible to get a small bank loan instead. The terms are usually less than a year, and can be provided for a large order or a seasonal inventory buildup. The advantage to a short-term loan is the low cost of financing, while the disadvantage is a lengthy and difficult approval process.