For most businesses, a common challenge is the efficient management of the company’s working capital. The cause may vary, but most times the customer just doesn’t pay on time. Be that as it may, an effective strategy to answer this problem is through the financing of the working capital.
Working Capital Financing Basics
You wouldn’t be using these loans to purchase assets or investments. Compared to the usual loans, a working capital loan is meant to address the short-term needs of the company’s operating expenses. That means company expenses such as payroll and rent can be paid for by the loan.
The reason these loans exist is that sometimes, a company will have a hard time keeping up with all these operational expenses due to varying reasons. As mentioned above, most cases are attributed to delayed payments on the customer’s part.
This usually applies to companies whose business relies on particular seasons or cycles. With that in mind, you can imagine how many of these sales are paid in installments or are paid at the end of a certain period.
Generally, there will be methods or strategies when discussing working capital management:
Aggressive
This strategy aims to give your company the best chance for profitability but at the cost of higher risk. Short-term funds will be financing your temporary capital and what expenses are left for the permanent working capital. Your permanent working capital should, as much as possible, be addressed by long-term funds.
Conservative
On the opposite end of the spectrum, a conservative approach will be the least risky strategy for capital management. Loans done under this strategy are often set with longer terms and, as a result, are often attached to higher interest rates.
This strategy will have the least liquidity risk but will also have the lowest chance of yielding rapid growth numbers.
Hedging
This strategy aims to match the loan terms with the maturation of the asset. This will mean that you will have to pay more attention to handling and planning. This is to make sure that there will be no lapses in any payments due
This strategy involves matching short-term assets to short-term loans and accordingly matching long-term assets to long-term loans.
Financing Your Working Capital
All in all, management of your working capital will require you to optimize cash flow within the company to allow for business growth and development. Any of these options should work; it will only depend on which is more appropriate for your company.
Take note though that most loans will require good credit. In the absence of good credit, asset-based loan terms will be the most likely option for the company in question.
Conclusion
We hope this article has helped give you a better understanding of how working capital financing actually works. As you can see, it can be quite useful especially for businesses that lack adequate cash on or flexible asset liquidity to take care of their operational expenses. Be sure to keep all of this in mind when considering this as an option for your business so you can make the best decision possible.
Porter Capital is a factoring company specializing in many services such as accounts receivable financing, freight financing, and asset-based lending in Alabama. We offer working capital solutions to businesses nationwide in various industries, providing over $6 billion in funding since our founding. Contact us today to find out more about what we can do for you!
