An entrepreneur needs to be many things: a visionary, leader, planner, marketer, and what’s too often forgotten, a financial analyst/accountant. Without this last role being fulfilled, great ideas and business can go nowhere because of problems which could have easily been foreseen with better knowledge of finance and accounting. One piece of the entrepreneurial puzzle which is essential to understand is working capital financing.
The Basics: How Working Capital Finance Can Become a Silent Business Killer
What is working capital? It is the amount by which your current assets exceed your current liabilities. In layman’s terms, this is your cash on hand. It’s the money you have available at the drop of a hat for whatever need may arise, whether it’s filling in a new order or paying your employees. Sounds simple, but the devil is in the details.
Here’s an example to illustrate the basic principles: let’s say your business manufactures bike helmets. You founded it because you had a revolutionary new design, and now, through your hard fought social media campaign, you’ve attracted a ton of interest. So, you manage to get an initial run of 10,000 orders at $50 per helmet.
It sounds as if everything is going perfectly — you’ve got $500,000 in sales on your first run. But the finance part of your brain should be rattling off questions at this point. Those helmets cost $30 each to produce, meaning you need $300,000 long before you’ll see a penny of that $500,000 from your retail partners.
Alternatively, for businesses which don’t deal with physical inventory, working capital financing issues can arise when you need to make payroll while still waiting to receive payment for delivered services. Ultimately, it’s an issue which is likely to arise in any growing business.
This is the fundamental difficulty of working capital management. Your business may be completely on track in terms of growth, sales, etc, but running into a drought of working capital can still cause everything to grind to a halt. In the worst cases it can kill an otherwise profitable business on the spot. So what do you need to understand about it to avoid a problem like this?
Master Working Capital Finance, Master your Business
Making yourself a master of your own working capital financing needs is ultimately all about acquiring a deep understanding of accounts receivable, accounts payable, and inventory. But beyond simply understanding the basic definitions of these terms, it’s about understanding how they can allow you to determine your working capital financing needs.
- Accounts Receivable: Here it’s all about calculating the average number of days it takes to collect payment on an account, not simply what the total number is.
- Accounts Payable: Just like with accounts receivable, the concern here is the average number of days it takes to pay a supplier’s invoice.
- Inventory: This can be calculated as the average number of days between receiving inventory and converting it into cash (i.e. accounts receivable). However, if your business doesn’t deal with inventory, you can leave this part out.
The basic equation of working capital finance is the average days for accounts receivable plus the average for inventory. If you compare this number to accounts payable, you’ll notice that gaps are inevitably going to occur. That’s when working capital financing tools become essential.
From Understanding to Solutions
Getting a grip on the subject is the first step, but that understanding isn’t going to solve your business’ working capital financing problems all on its own. Though it wouldn’t hurt to investigate more detailed studies. Fortunately, there are great financing options available.
FundThrough is the latest tool out there designed to help your business step over those working capital financing gaps with confidence. Thinking back to the bicycle helmet example, here’s how that situation would work with FundThrough:
- FundThrough creates a line of credit for matching the bike helmet company’s invoice amount (i.e. $500,000). Taken into consideration is the source of the company’s accounts receivable, not its financial history, so this brand new company actually has a chance to lift off. Let’s say those helmets are sold to a well-known retailer. Based on the high quality and reliability of the buyer, it will get its line of credit at a low interest rate.
- Once created, that line of credit is available whenever the business needs it with no minimums or commitment periods, so that it can take advantage of growth opportunities (i.e. big sales orders) whenever they may arise.
What does this mean for your business? It means you can increase your working capital when you need it with a low interest rate corresponding to the quality of the businesses your company deals with. For the bike helmet sellers, it means they can get through their dry period and start building on their initial sales success with confidence.
Taking Advantage of Growth Opportunities
So with FundThrough, it’s not only possible to solve your working capital financing problems, but to discover a tool for faster, more flexible growth. This can make all the difference in the world for your business. Instead of waiting up to 90 days for an invoice on an order, the income from that invoice can be reinvested immediately.