Working capital may not be a popular talking point compared to other startup buzzwords. However, having healthy working capital is crucial for a business to survive.

Most startup founders usually focus on the business’s financial bottom line—the profit. It is not saying that making a profit is not vital, but before thinking about the bottom line. Instead, there is a number that owners have to watch to determine if their businesses survive or sink—a working capital.

What is working capital, and why is it a number that startup founders need to pay attention to?

What is Working Capital?

Simply put, working capital is an accounting term that measures the difference between what a business currently owns against what it currently owes. The formula to calculate a business’s working capital is:

Working Capital = Current Assets – Current Liabilities

To define, current assets are the sum of the company’s cash, inventory, account receivables, and other assets that the company will turn to cash in one year. Meanwhile, employee wages, rent, taxes, utilities, accounts payable, and a portion of long-term debts composes the current liabilities. In short, current assets are the company’s properties and cash that are readily available within 12 months, while current liabilities are payables due within the same period.

Why Does It Matter?

Your working capital is the funds that your business needs to run its day-to-day operations. Positive working capital is vital to keep your business solvent. It also means that you have enough cash to fund investments that will help you produce more of your products or services and sell them.

Negative working capital does not bode well for your business’s financial health. A negative difference, most of the time, means that you may run out of cash to run and fund your business.

For example, if your company has available cash from last year’s retained earnings, you don’t invest it all at once. Else, your business will have trouble funding its daily operations. That is why it is important to have a business plan and learn business financing.

Now, the question would be, how and where can you access this fund? And, when do you need to acquire additional funding?

How to Access Working Capital?

How much working capital does a startup or a small business need? There is no fixed answer to this. Understanding how much your business needs will require studying the monthly cash flow. Knowing which month revenue and expenditure spikes and ebbs, you can project how much funds are needed to keep the business operations running.

Your projections will help you know in which month the cash flow is negative. Listed below are some of the most common scenarios when small businesses and startups need additional working capital:

1. Sales seasons affect most businesses. There are seasons where sales will rise and months that sales are lean.
2. Funding short-term obligations such as payment to suppliers and employees while waiting to cash the receivables, businesses will need more working capital.
3. To fund growth and expansion like purchasing bulk supplies.
4. Paying temporary workers and employees and other project-related expenses.
5. To be more attractive to investors. Maintaining healthy working capital is a sign that a business is well-managed.
6. Emergency preparedness. It is always prudent to have extra available funds during business emergencies.

Maintaining a positive working capital is a delicate balancing act. Even good financial management may not be good enough. That is why it is vital to have supplementary working capital. Here are some of the top ways to access short-term capital for your business:

Trade Creditors

Suppliers are always willing to help businesses. Most often, they offer trade credit when companies order in bulk. However, suppliers will first review the business’ credit history. So, having a well-managed and healthy financial history is a must.

Short-term Business Loans

For seasonal businesses, short-term business loans are the best recourse. This type of loan generally comes with fixed interest rates that small businesses can easily manage. These days, there are more alternative lending platforms that can provide businesses with unsecured credit lines.

Bank Overdraft

For small businesses, this is the easiest way to get supplementary working capital. Banks will only charge for the overdrawn money.

Equity Funding

Availed by businesses in the early growth stages where they get investments from friends, families, and even home equity loans.

Factoring Loan

This type of funding involves the business selling its invoices to a third party. To meet its daily operational funding needs, the company sells its future credit card receipts.

These are just a few ways small and mid-size business enterprises can access cash or fund for daily operations. With these working capital loans, SME founders no longer need to use their funds to address any immediate financial concerns to keep business operations running smoothly.

Improving Your Working Capital

However, there are ways for founders and SME owners to improve their business’ operational assets while keeping loans as the last option. Here are a few ways that business owners can work to improve their working capital:

• Encourage clients and customers to pay on time by using incentives. This will improve the business’s account receivables.
• Avoid paying penalties and increasing interest rates. Pay debts on time, availing of an electronic payment system expedites the debt-paying process.
• Save money through tax incentives. Allot these savings to your working capital fund.
• Ensure that you cut unnecessary expenses. Your expenses should focus more on what keeps your business running operationally smooth.
• Be more efficient with your inventory. Avoid stockpiling and instead make sure that you sell every item and that additional products arrive on time.
• Lastly, keep your options open. Have your business always ready to take capital loans for short-term operational needs.

Avoid These Mistakes

These tips will help you in improving your business financial management. However, the following instances are the mistakes that you need to avoid:

• Never confuse your business’s short-term working capital needs with long-term or permanent needs.
• Don’t tie up your working capital line of credit to purchase equipment and real estate or hiring permanent employees. These are different types of expenditures and need different types of funding.

Always remember that your short-term capital fund has an intended purpose. It keeps your business operations running smoothly on a day-to-day basis. This is why startup founders need to learn more about financial and accounting management. Proper management of cash inflow and outflow is a hallmark of good financial health to promote balance in growth, expansion, profitability, and liquidity.

At Full Scale, we specialize in aiding startups and SMEs manage their resources and grow. If you are looking to improve your financial management, our talented specialists will help you develop the right tools to make your daily operations as smooth as possible. You will also learn from our founders, both experienced and excellent entrepreneurs, who are very willing mentors to fellow startup founders.

Contact us today and let us work together to grow your business!