Working capital financing is done by various modes such as trade credit, cash credit/bank overdraft, working capital loan, purchase of bills/discount of bills, bank guarantee, letter of credit, factoring, commercial paper, inter-corporate deposits etc.
The arrangement of working capital financing forms a major part of the day to day activities of a finance manager. It is a very crucial activity and requires continuous attention because working capital is the money which keeps the day to day business operations smooth. Without appropriate and sufficient working capital financing, a firm may get into troubles. Insufficient working capital may result in nonpayment of certain dues on time. Inappropriate mode of financing would result in loss of interest which directly hits the profits of the firm.
Working capital loans are as good as term loan for a short period. These loans may be repaid in installments or a lump sum at the end. The borrower should take such loans for financing permanent working capital needs. The cost of interest would not allow using such loans for temporary working capital.
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.
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.
For example, if a business has £5,0000 in the bank, a customer that owes them £4,0000, an invoice from a supplier payable for £2,0000, and a VAT bill worth £4,0000, its working capital would be £3,0000 (5,0000 + 4,0000) – (2,0000 + 4,0000).
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.
Working capital loans
Working capital loans are normally over a short or medium term, designed to boost cash in the business to go after new opportunities. The size of the working capital loan you can get depends on many facets of your business profile.
Secured working capital loans will require assets to use as security, so the amount you can borrow is restricted by the assets available.
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