Working capital is a sure sign of a company’s health. When this particular health marker is low or nil, a company isn’t able to keep up with their short term expenses and monthly bills (ie., accounting liquidity).
Investors Not Likely to Help at This Point
When tough times set in, or have been present for a while, it’s difficult for a business to find investors willing to step in and help out. This is for good reason of course. If you’re unable to manage your day-to-day liabilities, and having nothing left over for equipment upgrades, expansion and marketing expenses, in most cases there isn’t a very good case being made for an investor to take a chance on you with their money.
Working capital, or a lack thereof, is also used to determine your credit worthiness. That’s why making securing the funds you need to get by even harder during the lean months. If you have lots of working capital, you’ll be viewed as a stable and responsible business. If you’re running low, or have none, then there will be lots of question marks surrounding your financial situation.
How Much Do You Really Need?
Every business needs it, but the end goal isn’t to obtain as much as possible. Having too much working capital is an indication that a business doesn’t have enough assets invested for the long-term. In anything related to the use of debt funding for raising capital, you have to find that sweet spot.
There’s no universal answer as to how much your unique business will need. Factors such as current cash flow, how fast (or if) you want to grow the business, profits-to-losses, and many others should be used to determine how much liquid cashflow you should have at the ready.
Some businesses will need less working capital because they have a short operating cycle (ie., how long it takes to turn sale’s revenue into cold hard cash). Other businesses have long operating and/or manufacturing cycles, making the need for large amounts of working capital essential to their survival.
Based on your operating cycle and current financial situation, develop three sets of projections: conservative, average and best-case-scenario. Go over these projections with your accountant. Figure out which is most likely given your current sales season and current and upcoming liabilities. After that, get to work on getting the capital you need.
5 Ways to Obtain Working Capital Without Seeking Investors
1. Line of Credit Through the Bank
If you’re running a new business, this may not be an option for you. However, banks usually don’t have a problem extending a line of credit to established businesses who have a history with their institution, and who have equity and collateral to offer in return. You’ll have to provide tons of documentation proving your ability to pay whatever amount you ask for back in short time.
Most lines of credit for businesses will be issued for a year, but all borrowed funds are expected to be repaid within 60 days after being borrowed, lest you wish to incur some hefty interest charges. This method of securing working capital is best used when you have large amounts of receivables coming in within a short time frame so you can pay it back quickly.
2. Private Lines of Credit
Most who’re in a situation where investors won’t touch them and working capital is low, will not be able to pass the bank’s screening protocol for a line of credit. Not to mention, banking lines of credit can take some time to process.
Private financiers will offer lines of credit with fewer processing hoops to jump through. Some offer on-the-spot approvals, though you may have to settle for a higher interest rate.
3. Supplier Credit
If obtaining raw materials to run your business is where most of your working capital goes, this option may be just what you need. You’ll need to have a good relationship with your suppliers in order to get extended payment terms with them.
Most require payment from you within 30 days of delivery. However, if you’re on good payment terms (ie., they’ve never or rarely had to chase you for their money), most will give you another month of leeway to help you stay on your feet.
They will want to see proof that you have outstanding purchase orders you haven’t collected on, and will usually place a lien on those payments to make sure they get their money back once those receivables are collected.
Factoring is very simple to obtain if you have outstanding receivables. Choose a factoring company and sell your receivables to them. Factoring companies based their rates on how old the invoice is and will advance up to 80% (minus factoring fee) of the invoice amount to you upon signing.
The rest will be delivered when your customer pays the invoice, minus the factoring company’s interest rate, which is dependent on how fast that customer pays – the faster they pay, the less interest will be subtracted from the remaining 20% owed to you.
5. Short-Term Loan
If you can qualify for a short term seasonal loan, go for it. This is yet another option when all other possibilities have been ruled out. Banks will offer businesses a short term loan to make up for seasonal inventory buildup. You’ll have to provide proof of your current inventory value and how you plan to liquidate it to pay the loan back.
Deciding Which is Right for You
One of the most important considerations for seeking out working capital that you don’t have is “How much is this going to end up costing me?” The least expensive options may not give you all the capital you need, whereas those like private lines of credit and factoring may give you a huge influx of cash with a hefty price tag (depending on how much you borrow).
Make sure you weigh all your options and what they’ll cost you before settling into one alternative over the other. Investments from VCs, angels, friends or family are usually far less taxing on profits. However, when you don’t have the means to secure investor funds, you have to do whatever you can to keep the doors open.