Primer On Working Capital
Simply put, working capital is the difference between the liquid assets and liabilities of your company. These assets are required to be liquid enough to sell within a year.
The type of assets that typically constitute working capital include:
- Property
- Inventory
- Cash
- Marketable securities
- Notes receivable
Liabilities factored into working capital include:
- Wages
- Rent
- Utilities
- Taxes
- Accounts payable
When factored together, your working capital sum will either show a surplus or a deficit. A surplus of working capital means that your business processes can flow uninterrupted. If your inventory is liquid—meaning you’re able to sell your stock quickly—you’ll see an increase in working capital.
Working capital represents assets that are working for your business. When your working capital is positive, your assets outpace your liabilities, generating positive growth in the long-term.
When working capital is at a deficit, the progress of your business is outpaced by growing debts and liabilities. Working capital inefficiencies often happen when demand is unpredictable. Here’s how:
Working Capital Inefficiencies
Say you’re selling an expensive mattress that most consumers can’t afford to purchase with a lump sum. You’d likely offer a payment plan where consumers pay a portion of the mattress’s price every month.
What happens if the demand for your mattresses skyrockets unexpectedly, but you don’t have enough liquid capital lying around to purchase excess inventory to fulfill the demand for orders because so many customers are paying over time? This financial stalemate represents a working capital inefficiency in your business—one that severely impairs your sales growth.
These kinds of working capital inefficiencies can cripple your business in the long term and cause you to lose much-needed revenue.
But don’t worry—for the duration of this guide, we’ll outline places to go and products to use when you want to increase your working capital. By the time we’re done here, you’ll understand how to invest in the long-term growth of your business in a way that mitigates and eliminates working capital inefficiencies.
Let’s get started.
Traditional Lenders
If you’ve ever tried to get a loan from a bank, you know 2 things:
- The process from application to completion takes forever
- Traditional lenders aren’t too keen on small business
Why does the application take forever? It’s because most lenders require you to fill out most of the following paperwork:
- Amount of money requested
- Intended purpose of the loan
- Your personal credit score
- Your business credit score
- Time in business
- Business plan
- Industry
- Entity type
- Business licenses and permits
- Employer identification number
- Proof of collateral
- Annual business revenue and profit
- Bank statements
- Balance sheet
- Personal and business tax returns
- Copy of your commercial lease
- How much debt you already owe
- Accounts receivable and payable reports
- Ownership and affiliations
- Legal contracts and agreements
Traditional loan applications have an 80% denial rate because the regulated structure of the modern banking system values large, stable investments over smaller, riskier investments like most small business proposals.
Ever since the 2008 recession, traditional lenders have had to consistently cut back on small business loans fulfilled every year due to heavy restrictions imposed on their lending practices. The majority of small businesses that make the cut are seasoned companies with a proven track record and impeccable credit.
These conditions leave out many startups, entrepreneurs whose enterprises have encountered serious roadblocks, and a whole slew of people who, for one reason or another, don’t have perfect credit.
Because of this, it’s hard to recommend loans from traditional lenders as a way to boost working capital.
However, if you’re OK with handling a 29-hour mountain of paperwork and waiting a few months or so to get the loan approved and the money deposited, a bank loan is a valid source of working capital.
The extra money can be invested in more business assets or held onto as protection against unexpected expenditures. The problem with using a bank loan for reserve working capital is that you’ll pay interest on the loan whether it’s working to make you money or sitting dormant.
There’s a better way. In fact, we’re about to talk about it.
Marketplace Lenders
If you’ve ever applied for financing at a marketplace lender like Lendio, you know 3 things:
- The application process is faster than a speeding bullet
- The loans are designed around the needs of small businesses
- The number of options available to your business is staggering
Rather than forcing you to spend hours of your day filling out mindless paperwork, lending marketplaces offer a fast application process that uses a single online application to match your business with financing options from a variety of lenders.
At Lendio, for example, our application takes only 15 minutes to complete. That’s about the time it takes to make a supercharged kale-avocado smoothie, and it’s just as good for your business as the smoothie is for your body.
Most lending marketplaces boast between a 60–70% approval rate for applicants. That application process is 116 times shorter for a 70% chance of getting approved. It’s really a no-brainer.
Also, it’s common to start receiving approvals for loans within the first 24 hours of applying, getting you the cash you need when you’re in a bind.
Almost 80% of small business owners who secured funding through online lending reported satisfaction with both the simpler application process and the shorter wait for a credit decision. Compare that to just half of traditional bank borrowers who report satisfaction.
In addition to providing an all-around more pleasant experience, marketplace lenders usually offer a plethora of loan types, each tailor-fitted to satisfy specific business needs.
These options give you the freedom to decide what your business needs to best improve its working capital.
Most Popular Working Capital Products
Businesses choose to increase working capital because they need a boost. But not every business needs the same kind of boost. That’s why we’ve narrowed down some of the best lending products that satisfy specific working capital needs.
Business Line of Credit
If you’re looking for a highly flexible financing option, a line of credit is right up your alley.
A line of credit acts as a financial safety net for your business. You have it available for when the need arises, but you’re not obliged to use it—there’s no penalty for not using it. And when you do tap into the money, it can be used for almost any business need you can dream up. Plus, you only ever pay interest on the money you use, so there’s absolutely no penalty for letting the money sit around for a bit.
So how exactly can I use my line of credit?
Lines of credit are very flexible and can be used for most business investments and expenditures. Popular uses include buying equipment, hiring staff, increasing inventory, adding a second location, paying invoices, installing a new employee refrigerator, and more.
And because lines of credit are revolving, you can use them as many times as you want. When you repay the funds, they’re immediately available again. Thus, a line of credit is like a loan that keeps on giving.
Qualifying and applying for a line of credit is pretty easy.
To get your business line of credit, you’ll typically need to be in business for at least 6 months and have $50,000 or more in annual revenue. You’ll also need a credit score of 560 or higher.
Your lender may ask you to make a personal guarantee, which is an agreement that the lender may be able to levy your personal assets such as a car, a house, or bank account if you default on the line of credit.
Lines of credit range from $1,000 to $500,000 of approved funds for your use and can be approved in as little as a week with interest rates starting at 8%.
Business Credit Card
Business credit cards are desirable for many of the same reasons a line of credit is desirable. Flexibility of use, convenience, and not paying interest if money isn’t being used.
In addition to the aforementioned benefits, business credit cards also have specific benefits associated with the type of card you choose to apply for:
0% Interest
Some business credit cards offer an introductory 0% APR. This perk usually only lasts for 12 months, but it’s a great benefit for a year’s worth of expenditures. Once the 0% APR period is over, you’ll have to start paying interest.
Bear in mind that interest accrues during the 0% period at the normal rate. The kicker is that you don’t have to pay any of that interest if you pay off your balance before the period is over. Be sure to pay off your credit card before the end of the period to avoid any interest.
Rewards and/or Cash Back
Many cards come with rewards or cash back programs. These kinds of programs make a lot of sense if you’re really good at paying off your balances each month.
By paying off your balance regularly, you’ll be able to earn cash back, miles, or any other perks offered for free. That’s right, free money. Getting free money to invest in your business is an obvious way to increase your working capital.
Flexible Applicant Requirements
You’re not required to put up collateral before getting a credit card, so businesses without a lot of assets can easily access one. Additionally, the credit score requirements and other business factors are very flexible.
Of course, you’ll get better rates if your credit score is good, but businesses with poor credit can still acquire a business credit card. As long as you pay off those balances faithfully, your credit will improve, and you’ll never have to pay a cent of interest.
Our business credit cards range from $1,000 to $500,000. Approval and funding can come in as little as a week and interest rates start at 8%. If you’re looking for an easy way to get some extra working capital, look no further.
Merchant Cash Advance
When famine or excess demand hit a business, it’s usually unexpected. A study by JPMorgan Chase found that the majority of small businesses only have enough cash to cover 27 days of average outflows. Of the businesses surveyed, even the top 25% only had a cash buffer sufficient for 2 months.
Most businesses are unprepared for the unexpected, which is where a merchant cash advance (MCA) comes in handy. It’s working capital that comes in clutch right when you need it.
Only 24 Hours to Funding
That’s right, you can have a merchant cash advance authorized and available to use in just 24 hours. That’s what really sets it apart from all other funding types. A merchant cash advance lets you borrow against future earnings to get the cash you need when you need it.
Mitigate Emergencies and Maximize Opportunities
Because merchant cash advances are so speedy, the most common uses for them usually fall into 2 categories: emergencies and opportunities.
Emergencies include an unexpected increase in demand, times of famine, equipment breakdowns, etc. Opportunities include property sales, equipment sales, urgent purchase opportunities, and more. A merchant cash advance makes it possible to mitigate emergencies and maximize opportunities when you don’t have the cash lying around to do so.
The only downside of an MCA is the high interest rate. It’s set at 18%, but that’s really a small concession when the need is urgent.
As far as working capital is concerned, a merchant cash advance couldn’t be a better solution for cashing in on those spur of the moment opportunities.
Crowdfunding
The final source of working capital we’ll look at is crowdfunding. Crowdfunding is growing at an exponential rate. Total crowdfunding raised in the US in 2016 was $738.9 million, and the projected total crowdfunding raised worldwide by 2025 is $300 billion.
So where does crowdfunding fit into the working capital discussion? Well, the fundamental problem with crowdfunding done through Kickstarter—the most common platform—is that only a very specific type of business works well.
A restaurant, for example, would find it nearly impossible to fund a new location using Kickstarter because the platform follows a reward-based crowdfunding model. What this means is that customers invest in the end product and expect a copy of said product in return.
Thus, crowdfunding works best for businesses looking to fund product development and dispersal. So if your business is product-based, Kickstarter may be a viable way to grow your working capital and finance your inventory. But that’s about it.
Backers don’t like the idea of their money being used for anything outside product development. While there’s no oversight as to how the funds are used when you get them, the success of your current and future campaigns rides entirely on your ability to deliver a high-quality finished product.
If you have money left over after you’ve delivered your product, its use is up to your discretion. Remember, however, that Kickstarter takes 5% of the total funding amount, so be sure to factor that into your calculations when putting a campaign together.
Other forms of crowdfunding are donation-based—where people don’t expect anything in return—but it’s difficult to generate business capital using these platforms. Platforms like GoFundMe are best utilized by nonprofit organizations looking to expand their services. If that’s not you, donation-based crowdfunding probably isn’t a viable option.
Are You Ready for Working Capital?
The real key with working capital is flexible funds that you can use to improve your business, stabilize your operations, and capitalize on unexpected opportunities. That’s why our team at Lendio has made it a goal to offer loan products that meet the working capital needs of any business.
While there are plenty of other financing routes to take, few offer the flexibility of a business credit card or line of credit. Almost none offer the speed and urgency of a merchant cash advance. Best of all, you can access these financial products by spending only 15-minutes filling out an application.
An application that we send to our proprietary network of over 75 lenders who compete for your business. So if you’re ready for the offers to start pouring in, get started on the application today.
