What Is Working Capital?
Working capital is a term used to describe the financial liquidity available to a business or organization. Working capital is also referred to as operating capital. This type of cash is a function of a business’s assets, which include both fixed assets such as plant and equipment, and short-term assets such as cash and accounts receivable. The amount of working capital is dependent on the number of fixed assets and the company’s overall risk.
Common errors in measuring working capital
Keeping track of your company’s working capital is important to keep your business afloat. It is also a good idea to consider ways to ensure that you have enough cash on hand to handle any potential financial emergencies.
Working capital is a complex topic, and there are many ways to go about optimizing it. For instance, you can increase your number of days in which you hold inventory, decrease the total amount of stock on hand, and improve the number of invoices you pay in a month.
A good start is to do a regular analysis of your current and past cash flow. By identifying areas for improvement, you can make a streamlined and efficient cash conversion cycle. As such, a small business banker can help you understand your needs and prepare for the future, even in the most challenging of circumstances.
A balance sheet is one of the most important tools in your financial arsenal, and is a must for any company looking to improve its bottom line. The balance sheet lists the business’s assets and liabilities.
Negative working capital
Negative working capital is a financial term that refers to the difference between your current assets and liabilities. Specifically, it describes how much you owe from customers. Depending on the industry, it can be 
beneficial or detrimental to your business.
It is important to understand what negative working capital is and how it affects your company. In order to do so, you should be familiar with the standard working capital cycle. If your company does not pay its bills on time, it is in a negative working capital position. The reason for this is that you are not using your available cash effectively.
There are several ways to determine if your company has negative working capital. First, check your Accounts Receivables line of your Balance Sheet. A high value on this line indicates that you are having trouble collecting money from your customers.
Another indicator is your Net Working Capital. This is the sum of your Accounts Receivables and your Inventory. Your company should have a net working capital ratio of at least one to 1.5 times.
Temporary working capital
Temporary working capital is a type of capital that is needed for short-term purposes. The amount of working capital a business needs depends on the nature of the business.
A seasonal business, such as a landscaping company, may require additional working capital during the season. For instance, a fruit juice manufacturer will purchase fresh fruits during the harvest season.
Similarly, a retail store may need to buy clothes from a manufacturer during the peak shopping season. In this case, a special working capital loan may be needed. If a business is expecting an increase in sales, it may also need to expand its marketing efforts.
In a stable business, small fluctuations are acceptable. But if a business is scaling up, it will experience more significant changes in its operating costs. Therefore, it is important to keep an appropriate level of working capital.
Whether a company should apply for temporary or permanent working capital depends on many factors. Generally, it is best to use long-term sources for permanent needs.
Reserve working capital
Reserve working capital is a special fund that is kept aside to meet unexpected expenses or business needs. This type of fund is useful when unforeseen events are likely to arise, such as in the case of an 
unexpected market opportunity or a sudden surge in the company’s business.
Businesses need to maintain a reserve working capital to ensure smooth operations. In order to maintain a reasonable level of regular working capital, a business will need to monitor and track monthly inflows and outflows. It is important to also keep an eye on the overall financial health of the company. If a company does not have a good working capital management strategy in place, it could run into a variety of problems.
One of the ways a business can increase its reserve working capital is through a short-term loan. This loan can be used to finance the cost of temporary staffing or to purchase goods in bulk. A working capital loan can also be used to pay for the expenses associated with a project, including advertising campaigns and marketing research.
Here are definitions for the some terms related to working capital:
Working Capital:
- Working capital represents the difference between a company’s current assets and current liabilities. It reflects the short-term financial health and liquidity of a business.
Current Assets:
- Current assets are assets that are expected to be converted into cash or used up within one year. Examples include cash, accounts receivable, and inventory.
Current Liabilities:
- Current liabilities are obligations that are due within one year. Examples include accounts payable, short-term loans, and accrued expenses.
- Short-term financing refers to borrowing or financial arrangements with a maturity of one year or less, often used to address immediate working capital needs.
Liquidity:
- Liquidity measures the ability of a company to meet its short-term obligations using its available assets. High liquidity indicates a greater ability to cover short-term debts.
Cash Flow:
- Cash flow represents the movement of cash into and out of a business. Positive cash flow indicates more cash coming in than going out.
Operating Cycle:
- The operating cycle is the time it takes for a company to convert its resources (raw materials, labor) into cash through the sale of goods or services.
Net Working Capital:
- Net working capital is the difference between a company’s current assets and current liabilities. A positive value indicates more assets than liabilities.
- Business finance involves managing the financial aspects of a business, including obtaining funds, budgeting, and making strategic financial decisions.
Working Capital Management:
- Working capital management involves overseeing a company’s short-term assets and liabilities to ensure efficient use of resources and maintain liquidity.
Working Capital Ratio:
- The working capital ratio (current ratio) is calculated by dividing current assets by current liabilities, providing an indication of a company’s short-term liquidity.
Cash Conversion Cycle:
- The cash conversion cycle measures the time it takes for a company to convert its investments in inventory and other resources into cash through sales.
Capital Adequacy:
- Capital adequacy assesses whether a company has enough capital to cover its operational needs and potential risks, ensuring financial stability.
Funding Operations:
- Funding operations involves securing financial resources to support day-to-day business activities, including paying suppliers and employees.
Working Capital Turnover:
- The working capital turnover ratio measures how efficiently a company uses its working capital to generate sales revenue.
Capital Expenditure:
- Capital expenditure refers to investments in long-term assets, such as equipment or property, that are expected to benefit the business over an extended period.
Trade Credit:
- Trade credit is the practice of buying goods or services on credit, allowing businesses to defer payment to suppliers for a specified period.
Accounts Receivable:
- Accounts receivable are amounts owed to a company by customers for goods or services delivered on credit.
Inventory Management:
- Inventory management involves overseeing the acquisition, storage, and utilization of inventory to meet customer demand while minimizing holding costs.
Short-Term Loans:
- Short-term loans are borrowed funds with a maturity of one year or less, commonly used to address immediate financing needs or working capital requirements.
These definitions cover key concepts related to working capital and business finance.
FAQ
Frequently Asked Questions
How can SBA loan be used?
Small Business Administration (SBA) loans are designed to support small businesses by providing financing for various purposes. The allowable uses of an SBA loan can depend on the specific type of loan program, but generally, SBA loans can be used for the following purposes:
- Working Capital:
- SBA loans can be used to cover day-to-day operational expenses, such as payroll, rent, utilities, and inventory. This helps businesses maintain their cash flow.
- Equipment Purchase:
- Businesses can use SBA loans to finance the purchase of equipment, machinery, or other tangible assets needed for their operations.
- Real Estate Purchase or Lease:
- SBA loans can be used to acquire, construct, or lease commercial real estate for the business. This includes buying land, buildings, or financing leasehold improvements.
- Business Expansion:
- Businesses looking to expand their operations can use SBA loans to fund the expansion, whether it’s opening new locations, entering new markets, or increasing production capacity.
- Debt Refinancing:
- SBA loans may be used to refinance existing business debts, providing businesses with the opportunity to consolidate debt and potentially secure more favorable terms.
- Inventory Purchase:
- Businesses in retail or manufacturing can use SBA loans to finance the purchase of inventory. This is particularly helpful during peak seasons or when dealing with large orders.
- Startup Costs:
- For eligible businesses, certain SBA loan programs can be used to cover startup costs, including expenses related to establishing a new business.
- Franchise Financing:
- SBA loans can be used by entrepreneurs to finance the purchase of a franchise or to open a new franchise location.
- Working Capital for Exporting Businesses:
- Exporting businesses can use SBA loans to support working capital needs related to exporting goods or services.
- Debt Service:
- SBA loans may be used to cover regular debt service payments, helping businesses manage their debt obligations.
Important Points to Consider:
- Loan Terms and Conditions: The terms and conditions of SBA loans, including interest rates, repayment periods, and allowable uses, may vary depending on the specific loan program.
- Business Eligibility: Businesses must meet certain eligibility criteria to qualify for SBA loans. This includes being a small business, operating for profit, and meeting industry-specific requirements.
- Use Restrictions: While SBA loans provide flexibility, there may be some restrictions on certain uses. It’s essential to review the specific terms of the loan program to understand any limitations.
- Documentation Requirements: Businesses seeking an SBA loan will need to provide detailed documentation regarding their financial health, business plan, and how the loan funds will be used.
Business owners interested in obtaining an SBA loan should work closely with an SBA-approved lender, such as a bank or credit union. Additionally, consulting with financial advisors or SBA resource partners can provide guidance on the best use of SBA loan funds for a particular business’s needs.
How to go about getting a small business loan?
How to Get a Small Business Loan: A Step-by-Step Guide
- Determine Your Loan Purpose: Clearly define the purpose of the loan, whether it’s for working capital, equipment purchase, expansion, or other needs.
- Assess Your Creditworthiness: Check your personal and business credit scores. Aim to improve your creditworthiness if needed.
- Create a Detailed Business Plan: Develop a comprehensive business plan outlining your business model, goals, financial projections, and how you plan to use the loan.
- Gather Financial Documents: Prepare financial statements, including income statements, balance sheets, and cash flow statements.
- Research and Choose the Right Type of Loan: Explore different types of small business loans, considering traditional banks, SBA loans, online lenders, and alternative financing options.
- Identify Potential Lenders: Research and identify potential lenders based on reputation, loan terms, interest rates, and customer reviews.
- Check Eligibility Criteria: Review the eligibility criteria of selected lenders to ensure your business meets the requirements.
- Prepare Loan Application: Complete the loan application form provided by the chosen lender, attaching all required documents.
- Negotiate Loan Terms: Review and negotiate the terms, including interest rates, repayment terms, fees, and collateral requirements.
- Undergo the Approval Process: The lender will review your application, conduct due diligence, and assess your creditworthiness.
- Receive and Review Loan Offers: Once approved, carefully review loan offers, understanding all terms and conditions.
- Accept the Loan and Fulfill Conditions: Formally accept the selected loan offer and fulfill any conditions specified by the lender.
- Receive Funds and Use Responsibly: After meeting all requirements, the lender will disburse the funds. Use the loan responsibly according to your business plan and the agreed-upon purpose.
- Monitor and Repay the Loan: Regularly monitor your business’s financial performance and adhere to the agreed-upon repayment schedule.
Tips:
- Build Relationships: Establish a positive relationship with your lender for potential future financial needs.
- Seek Professional Advice: Consider consulting with financial advisors, accountants, or business consultants for informed decision-making.
Remember that the small business loan application process may take time, so be patient and diligent in preparing and submitting all required documentation.
What happens if you get a business loan and the business fails?
If a business fails after obtaining a business loan, it can have various consequences for the business owner and the lender. The specific outcomes depend on the terms of the loan, the presence of personal guarantees, and the actions taken by both parties. Here are some common scenarios:
- Loan Repayment Obligations:
- Personal Liability: If the business owner provided a personal guarantee for the loan, they may be personally responsible for repaying the outstanding balance, even if the business fails. Personal guarantees are common in small business loans, and they extend the lender’s ability to collect from the personal assets of the business owner.
- Business Assets: In the absence of a personal guarantee, the lender may look to the business’s assets to recover the outstanding debt. This could involve selling business equipment, inventory, or other assets to recoup some of the losses.
- Default and Collection Actions:
- Legal Action: If the business defaults on the loan, the lender may take legal action to recover the outstanding debt. This could include obtaining a judgment against the business owner and seizing assets through legal means.
- Collections: Lenders may hire debt collection agencies to pursue repayment. Collection efforts can include phone calls, letters, and other methods to encourage payment.
- Bankruptcy:
- Business Bankruptcy: If the business is unable to repay its debts, it may file for bankruptcy. Depending on the type of bankruptcy (Chapter 7, Chapter 11, or Chapter 13), the business’s assets may be liquidated, or a repayment plan may be established.
- Personal Bankruptcy: If the business owner provided a personal guarantee and is personally liable for the debt, they may consider personal bankruptcy as a last resort. Bankruptcy has significant legal and financial implications and should be carefully considered after seeking legal advice.
- Negotiation and Settlement:
- Loan Restructuring: In some cases, lenders may be open to negotiating loan restructuring or settlement terms. This could involve modifying the repayment schedule, reducing the total amount owed, or reaching a settlement agreement.
- Debt Settlement: The business owner may negotiate with the lender to settle the debt for a lesser amount than the total owed. However, this approach may negatively impact credit scores and may have tax implications.
It’s crucial for business owners facing financial difficulties to communicate openly with their lenders. Many lenders prefer to work with borrowers to find solutions rather than resorting to legal action. Seeking professional advice from financial advisors, attorneys, or counselors can help navigate the options available and make informed decisions during challenging times.
It’s important to note that the specific outcomes will depend on the terms of the loan agreement, the legal structure of the business, and the applicable laws in the jurisdiction where the business operates.
How to get a small business loan for a woman?
Securing a small business loan for women involves similar steps to obtaining financing for any business. However, there are specific resources and programs that cater to women entrepreneurs. Here’s a guide on how to get a small business loan for a woman:
1. Develop a Solid Business Plan:
- A well-prepared business plan is crucial. Outline your business concept, target market, revenue model, and financial projections. Clearly define how the loan will be used and how it will benefit your business.
2. Check Your Credit Score:
- Assess your personal and business credit scores. A good credit history enhances your eligibility for loans. If needed, work on improving your credit score by addressing any outstanding issues.
3. Explore Women-Centric Loan Programs:
- Many organizations and lenders offer loan programs specifically for women entrepreneurs. Explore options provided by institutions supporting women in business.
4. Research Government Programs:
- Investigate government-backed loan programs, such as those offered by the Small Business Administration (SBA). The SBA has programs like the Women-Owned Small Business (WOSB) Federal Contracting Program.
5. Seek Women-Focused Financial Organizations:
- Some financial institutions and organizations specialize in providing financial support to women-owned businesses. Research and connect with these entities to explore financing options.
6. Join Women Entrepreneurial Networks:
- Being part of women entrepreneurial networks can provide valuable insights and connections. Some networks offer mentorship programs and financial resources for women in business.
7. Consider Microloans:
- Microloans are smaller loans offered by community lenders or microfinance institutions. These may have less stringent eligibility criteria and can be suitable for startups or small businesses.
8. Explore Online Lenders:
- Online lenders often have streamlined application processes. Research online platforms that support women entrepreneurs and consider applying for loans tailored to small businesses.
9. Look into Local Initiatives:
- Check for local initiatives or programs supporting women-owned businesses. Local chambers of commerce, business development centers, and community organizations may offer resources and guidance.
10. Prepare Financial Documents:
- Gather necessary financial documents, including business financial statements, tax returns, and any other information required by lenders. Organized financial documentation strengthens your loan application.
11. Consider Collateral and Guarantees:
- Be prepared to discuss collateral options and, if necessary, provide personal guarantees. This can increase your chances of loan approval.
12. Build a Strong Relationship with Your Bank:
- Establishing a good relationship with your bank can be beneficial. Discuss your business plans with your banker and inquire about small business loan options.
13. Attend Workshops and Training Programs:
- Attend workshops and training programs focused on women entrepreneurs. These events may provide insights into funding opportunities and strategies for obtaining loans.
14. Network and Connect:
- Attend networking events, conferences, and industry gatherings. Building a strong professional network can open doors to potential lenders and investors.
15. Consult with Business Advisors:
- Seek advice from business advisors, mentors, or consultants who have experience in assisting women entrepreneurs. They can provide guidance on the loan application process.
16. Be Persistent and Persevere:
- Obtaining a small business loan can take time. Be persistent, follow up on your applications, and explore multiple avenues until you find the right financing option.
Important Tip:
Education and Preparation: Educate yourself about available funding options and be well-prepared before applying for a loan. Understanding the terms and conditions will empower you to make informed decisions.
Remember that securing a small business loan requires careful planning and perseverance. By leveraging resources available to women entrepreneurs and demonstrating a strong business plan, you increase your chances of obtaining the financing needed for your business.
How to determine how much working capital a business needs?
How to Determine How Much Working Capital a Business Needs
- Calculate Current Assets: Identify and calculate the total value of your current assets. Current assets include cash, accounts receivable, inventory, and any other assets expected to be converted into cash or used up within one year.
- Determine Current Liabilities: Identify and calculate the total value of your current liabilities. Current liabilities include accounts payable, short-term loans, accrued expenses, and other obligations due within one year.
- Calculate Net Working Capital: Subtract the total value of current liabilities from the total value of current assets to calculate the net working capital.
Formula: \( \text{Net Working Capital} = \text{Current Assets} – \text{Current Liabilities} \) - Assess Business Cycle and Seasonality: Consider the nature of your business and its industry. Some businesses experience fluctuations in demand or seasonal variations. Assessing these factors helps determine peak working capital needs during specific periods.
- Analyze Cash Conversion Cycle: Evaluate the cash conversion cycle, which involves the time it takes for cash to be invested in inventory, sold as a product, and then converted back into cash through customer payments. A shorter cash conversion cycle often requires less working capital.
- Review Historical Financial Data: Analyze historical financial statements to identify patterns and trends in working capital requirements. Look for seasonal variations, growth trends, and changes in the business environment.
- Consider Growth Plans: If your business is planning to expand or launch new products/services, consider the impact on working capital needs. Growth often requires additional investment in inventory, receivables, and other operational aspects.
- Factor in Accounts Receivable Aging: Evaluate the aging of accounts receivable to understand the average time it takes for customers to pay. This information helps in estimating the necessary working capital for receivables management.
- Assess Inventory Turnover: Calculate and analyze inventory turnover ratios to understand how efficiently your business is managing inventory. Faster inventory turnover may reduce the need for excessive inventory and related working capital.
- Review Payment Terms with Suppliers: Assess the payment terms with suppliers. Negotiating favorable terms can positively impact working capital needs by extending payment periods.
- Use Working Capital Ratios: Calculate working capital ratios such as the current ratio (current assets/current liabilities) and quick ratio (quick assets/current liabilities). These ratios provide insights into the liquidity and working capital position.
- Consider External Factors: Be mindful of external factors such as economic conditions, industry trends, and regulatory changes. These factors can influence working capital requirements.
- Seek Professional Advice: Consult with financial advisors, accountants, or industry experts for guidance in assessing and determining the appropriate level of working capital for your business.
Determining the right amount of working capital is a dynamic process that requires ongoing monitoring and adjustment. Regularly reviewing and updating your working capital calculations will help ensure that your business has the necessary resources to operate efficiently and weather changes in the business environment.
How long can you get a small business loan for?
The duration, or term, of a small business loan can vary widely depending on the type of loan, the lender, and the specific terms negotiated between the borrower and the lender. Here are common types of small business loans and their typical terms:
- Short-Term Loans:
- Duration: Usually ranges from a few months to two years.
- Purpose: Designed to cover short-term financing needs, such as working capital, inventory purchases, or temporary cash flow gaps.
- Medium-Term Loans:
- Duration: Typically two to five years.
- Purpose: Used for larger expenditures like equipment purchases, expansion projects, or business renovations.
- Long-Term Loans:
- Duration: Can extend beyond five years, sometimes up to 25 years.
- Purpose: Suitable for substantial investments, such as real estate acquisition, business acquisition, or major capital expenditures.
- SBA Loans:
- Duration: Varies depending on the specific SBA loan program.
- Purpose: SBA 7(a) loans can have terms of up to 10 years for working capital and up to 25 years for real estate. SBA 504 loans for real estate and equipment can have terms of 10, 20, or 25 years.
- Business Lines of Credit:
- Duration: Typically revolving with no fixed term. Renewed annually.
- Purpose: Used for ongoing working capital needs, allowing businesses to draw funds as needed.
- Invoice Financing:
- Duration: Can be short-term.
- Purpose: Helps businesses manage cash flow by providing advances based on outstanding invoices.
It’s important to note that the loan term is a key factor in determining the overall cost of the loan. Shorter-term loans often have higher monthly payments but lower total interest costs, while longer-term loans may have lower monthly payments but higher overall interest expenses.
When considering a small business loan, it’s crucial to carefully review and negotiate the terms, including the interest rate, fees, and repayment schedule. Additionally, the purpose of the loan and the business’s financial situation should align with the chosen loan term to ensure that the financing meets the business’s needs without creating unnecessary financial strain.
Always consult with the lender and carefully read the loan agreement to fully understand the terms and conditions before committing to a specific loan term.
Can i get a small business loan with no credit?
Obtaining a small business loan with no credit or poor credit can be challenging, as lenders typically use credit history to assess the borrower’s creditworthiness and risk. However, there are alternative options and strategies you can explore:
- Consider a Secured Loan:
- Secured loans are backed by collateral, such as business assets or personal assets. If you have valuable assets that can be used as collateral, it may increase your chances of approval.
- Look for Microloans:
- Microloan programs, often offered by nonprofit organizations and community lenders, may have more flexible eligibility criteria and be willing to work with businesses with limited or no credit history.
- Explore Peer-to-Peer Lending:
- Peer-to-peer lending platforms connect borrowers directly with individual investors. Some platforms may have less stringent credit requirements compared to traditional banks.
- Seek Alternative Lenders:
- Alternative lenders, including online lenders and fintech companies, may have more lenient credit requirements. However, be cautious of higher interest rates and fees associated with some alternative lending options.
- Apply for a Business Credit Card:
- Business credit cards often have more lenient requirements than traditional loans. They can be used for smaller financing needs and can help build a positive credit history for your business.
- Build Business Credit:
- Start building a positive business credit history by establishing trade credit with suppliers, paying bills on time, and maintaining healthy financial practices. Over time, a positive credit history may improve your ability to qualify for loans.
- Explore Government Programs:
- Some government-backed loan programs, such as those offered by the Small Business Administration (SBA), may have options for businesses with limited credit history. SBA microloan programs, for example, may be accessible to startups and businesses with modest credit.
- Bring on a Co-Signer or Partner:
- If possible, consider bringing on a co-signer or business partner with a strong credit history. This can increase the likelihood of loan approval and potentially secure more favorable terms.
- Build a Strong Business Plan:
- A well-prepared and detailed business plan can help demonstrate to lenders that your business is viable and has a clear strategy for success. Emphasize your business’s strengths, potential for growth, and how you plan to use the loan.
- Work with Local Community Banks:
- Local community banks may be more open to working with businesses in their community and may have more flexible lending criteria compared to larger banks.
While it’s challenging to secure a small business loan with no credit, exploring these alternative options and diligently building your credit over time can improve your chances of obtaining financing. Be sure to carefully review the terms and conditions of any loan offer and consider seeking advice from financial professionals to make informed decisions.
Can you get a small business loan for real estate?
Yes, it is possible to get a small business loan for real estate. Small business owners often seek financing options to purchase or improve commercial properties. Lenders may offer different types of loans for real estate, such as commercial mortgages, SBA (Small Business Administration) loans, or conventional business loans.
Here are a few options you may consider:
- Commercial Real Estate Loans: Traditional banks and lending institutions provide commercial real estate loans. These loans are specifically designed for purchasing or refinancing commercial properties.
- SBA 7(a) Loans: The Small Business Administration offers 7(a) loans, which can be used for various business purposes, including real estate. SBA loans often have favorable terms, but the application process can be more extensive.
- SBA 504 Loans: Another SBA program, the 504 loan, is specifically tailored for real estate and equipment purchases. It involves a partnership between a Certified Development Company (CDC), a lender, and the business owner.
- Conventional Business Loans: Some businesses opt for conventional loans from banks or financial institutions to finance real estate acquisitions. The terms and interest rates may vary based on the lender’s policies.
Before applying for a loan, it’s essential to assess your business’s financial health, prepare a detailed business plan, and gather the necessary documentation. Additionally, be aware of the specific requirements and eligibility criteria of the chosen loan option.
It’s recommended to consult with financial advisors or loan officers to explore the best financing options based on your business needs and financial situation.