By:
Phd in Finance
Investment&Finance Advisor for Real Estate
Working capital finance is business finance designed to boost the working capital available to a business. It's often used for specific growth projects, such as taking on a bigger contract or investing in a new market.
Different businesses use working capital finance for a variety of purposes, but the general idea is that using working capital finance frees up cash for growing the business which will be recouped in the short- to medium-term.
There are many different types of lending that could be considered working capital finance. Some are explicitly designed to help working capital (whatever industry you’re in), while others are useful for specific sectors or requirements.
How to raise working capital finance
Working capital is the amount of cash a business can safely spend. It’s commonly defined as current assets minus current liabilities. Usually working capital is calculated based on cash, assets that can quickly be converted to cash (such as invoices from debtors), and expenses that will be due within a year.
What is the formula for working capital?
For example, if a business has £5,000 in the bank, a customer that owes them £4,000, an invoice from a supplier payable for £2,000, and a VAT bill worth £4,000, its working capital would be £3,000 = (5,000 + 4,000) - (2,000 + 4,000).
Liquid cash
Working capital is seen as ‘working’ because the business can use it — in other words, it’s not tied up in anything long-term. Whether you want to buy stock, invest in the business, or take on a big contract, all of these activities require working capital — cash that’s quickly accessible.
On the other hand, if your business is profitable but has big bills to pay soon, your working capital situation could be worse than it might seem — or could even be negative.
How is working capital financed?
Here are some of the more common types of working capital finance.
How is working capital efficiency calculated?
Working capital efficiency is determined using the working capital ratio. This is a business’ current assets divided by its current liabilities. It informs investors and others as to whether the company has the current means to meet its short-term obligations.
What is a good working capital?
Typically, a working capital ratio between 1.2 and 2.0 is considered satisfactory. A working capital ratio of below 1 suggests potential cash problems.
What happens if working capital is too high?
Higher doesn’t always mean better. For instance, a very high working capital ratio could indicate that a business isn’t investing its surplus capital into its growth, but is instead missing opportunities by letting its cash and assets lay dormant.
Do you want high or low working capital?
Companies should always aim for healthy working capital. A business’ working capital can fluctuate - for instance, it may experience seasonal peaks and dips.
What kinds of businesses require the most working capital?
One company might require more working capital than another because expenses and business needs vary from one industry to another. Take a retail business for instance. It may need a lot of available cash to purchase inventory. A tech company, on the other hand, might not - especially if it operates remotely.
How do you control working capital?
To help maintain a healthy flow of working capital, businesses can manage inventory effectively, always pay suppliers on time, pay debts on time, fine tune the accounts receivables process and, if needed, consider financing options.
There are many types of working capital financing available, and choosing the right product depends on your sector and circumstances, as well as what you're trying to achieve. To find out more about working capital financing, browse the related articles below or get in touch.
