Small businesses often find that they run into hard times in terms of having enough working capital on hand. In fact, many small businesses will have a hard time figuring out exactly how much working capital that they need at any given time of the year. These problems can be a serious detriment to the operations of small businesses, even when the company is successful and profitable. To remedy these financial issues, many businesses will take out a working capital loan, but there is more to the issue than just knowing that you need more money for operating expenses.
Understanding Your Operating Cycle
The first step in getting a grasp on your working capital needs is to analyze the operating cycle of your business. In the most basic sense, the operating cycle is the average number of days that it takes for various financial processes to occur within the operations of the business.
For your accounts payable, this would be the number of days that it takes for your business to pay a supplier. For accounts receivable, it would be the average number of days that it takes to collect payment from a customer. Lastly for inventory, it would be the average number of days that it takes your business to turn new inventory around into a sale.
Identifying Any Shortages in Financing the Operating Cycle
Once you understand the operating cycle of the business, you will be much better equipped to find the areas where your cash on hand and profits are not keeping up with the operating needs of your business. You may find that certain months are a little slow, and this could lead to a shortfall in funds that may hurt your ability to meet the working capital needs of the business. Another example could be the need for inventory when your receiving cycle is running slow.
With many small businesses, it is hard to finance the operating cycle with the money that comes in through sales alone. The gap may be covered by net profits, but the money is not turning around fast enough to meet the operating expenses. For those situations, a business can look to use a working capital loan to keep things moving.
One situation where it may be hard to meet working capital needs is during the approach of a peak season. When a peak is on the horizon, a company may need to spend more money on inventory to stock up for the additional business, but the revenue generated during the time leading up to the peak may not be enough to adequately prepare. To meet this increased need, the company will take out a loan, knowing that the peak season will provide enough income to make the loan payable.
Temporarily Supplement Cash Flow
A company may also employ a working capital loan to supplement their cash flow during times that are slow. Many businesses will have times of the year when they are operating at a loss. To avoid having to close down completely, they will use the loan to cover the shortfall during the slow months. When business picks back up, the business will then be able to repay the lender.
A working capital loan can offer a lot of benefits to a company. The first way in which it is a benefit is that it ensures that the business will be able to handle any temporary financial issues that may arise. Instead of having financial stress because a particularly large bill came in, or you needed to have a piece of equipment repaired, the business will have the money to cover these expenses and meet all of the regular financial obligations that they have. In addition to that, these loans are usually very quick and simple to obtain, and they can provide an infusion of cash for just about any operating expense that could arise.
Access to a working capital loan is essentially a way of providing your business with financial security. If you are constantly running tight on working capital, it can seriously limit a company’s ability to operate and this can lead to financial damage that could be hard to undo.