Working Capital Finance

What is working capital finance, and why is it important?

Every business relies on cash, or working capital, to operate and grow. But steady cash flow, year-round, isn’t always easy to sustain. Most small to mid-sized businesses need to finance this type of capital at some point, whether it’s to maintain cash flow or capitalize on growth opportunities.

What is working capital finance?

Working capital finance is a type of funding that enables businesses to meet short-term obligations such as payroll, bills and other day-to-day expenses.

Most accountants define “working capital” as current assets minus current liabilities. In other words, a business’s working capital is what it has in cash on hand, accounts receivable and inventory after deducting accounts payable and other debts such as business loans.

Ideally, current assets should be equal to or greater than current liabilities. If they are not, working capital financing can help a business access more cash so it can fund everyday business expenses and make growth investments.

Types of working capital financing

• Working capital loans. Businesses can apply for loans from a bank or alternative lenders to finance working capital. Loans are lump sums that must be repaid with interest in monthly installments.
• Business lines of credit. Lines of credit offer revolving financing and function similarly to a credit card. This means a business can draw funds up to its credit limit, paying interest only on the borrowed cash. Available funds replenish as soon as they are repaid.
• Overdrafts. Overdraft protection is similar to a line of credit, allowing businesses to make purchases beyond their bank account balance, up to a limit, for a fee.
• Invoice discounting. This strategy incentivizes buyers to pay invoices early, making funds immediately available, in exchange for a small discount. Rather than borrowing from a third party, a supplier can finance working capital by offering buyers a discount directly. 

Some other working capital financing strategies include supply chain financing, invoice factoring, angel investments and personal loans funded by family and friends. Innovative fintech companies also enable businesses to easily combine several financing strategies to optimize cash flow, such as C2FO’s Capital Finance and Early Payment program.

Why is this important?

Sufficient cash is central to a business’s financial stability and growth. But smaller businesses often experience inconsistent cash flow, either because the business is still establishing itself or its industry is subject to seasonality and other fluctuations. That’s why working capital financing, in some form, is often necessary for small to mid-sized businesses. It can help cover short-term expenses and enable companies to sustain operations or expand their business. 

It is also crucial for navigating lengthy payment terms. Even if a business is consistently profitable, it may still struggle to maintain the necessary capital on hand if it must wait 60, 90 or more days for customers to pay invoices. Additionally, regardless of how healthy the business’s cash flow is, working capital financing can provide the cash necessary to make growth investments.

The benefits of this type of financing

• Increase cash on hand and address cash shortages. Working capital financing gives businesses reliable access to the funds needed to meet everyday expenses.
• Fund working capital efficiently. Lenders are usually willing to process applications faster for working capital financing. Many also offer more flexible terms and zero collateral requirements. 
• Access equitable funding sources. Working capital financing solutions such as C2FO’s Early Payment program are accessible to small to mid-sized businesses that may not qualify for traditional working capital loans. 
• Navigate long payment terms. Business loans and lines of credit bridge cash gaps caused by extended payment terms, while invoice discounting helps suppliers get paid faster — 32 days early with C2FO, on average.
• Grow the business. This type of financing allows businesses to purchase or lease new equipment, open new locations, establish a cash reserve and make other growth investments.
• Improve customer relationships. Secure the cash needed to meet increased demands from buyers and consistently deliver goods on time and in full. 
• Manage working capital more easily. Platforms such as C2FO’s makes it easier to monitor cash flow and optimize working capital finance opportunities.