All businesses need cash to grow and thrive. Working capital for small business is one of the fundamental requirements for sustaining and succeeding in the long run.
Working capital is
nothing but the amount of money required for the day to day operations of the
company. You can calculate how much working capital your business has by
subtracting the current liabilities from the current assets. You can group
anything that converts into cash within a year under current assets and
classify anything due within a year as current liabilities.
While we all know
that shortage of working capital is bad for business, excess working capital is
also not recommended as companies end up sitting on idle cash that can generate
better returns elsewhere. Due to this caveat, businesses often struggle between
balancing too little and too much cash when it comes to working capital.
The question then
arises, how much working capital does your business require?
How much working capital you need to run your business depends on the business type, the operating cycle, and the business’s future aspirations.
Here are a few factors to consider while assessing Working capital for small business
1. Business cycle:
Is there a time difference between the revenues coming in and the expenses that must be met? The larger the time difference, the more would be the requirement for working capital.
For example, let us
assume the company pays for inventory 30 days after receiving it. It sells the
product 15 days later, and the receivables from the customer come in a month
later. The working capital gap then is 45 days. The company needs to estimate
the expenses required to meet in this period (salaries, rent, office expenses,
marketing expenses, and utilities.) It must also account for a certain
percentage of unplanned expenditure. These funds need to be made available as
working capital.
2. Business model:
Does the business require higher working capital finance due to its heavy inventory nature or requires higher processing time to convert to finished goods? If the company is inventory heavy and needs longer processing times, it would need higher working capital. In contrast, a service-oriented business that requires little or no inventory needs working capital only to the extent of expenses it costs to run the company’s operations.
Apart from the business model, if your offerings are impacted by seasonality, your working capital requirements might fluctuate during peak periods and off-seasons. For instance, an air conditioning business might require higher inventory before summers but not otherwise. If seasonality affects your business, your working capital needs fluctuate during the year, and it might be advisable to arrange for a working capital loan to fund peak seasons.
3. Growth plans and stage:
Working capital for small businesses could differ depending on the maturity of the company. Companies just starting up or those in their growth or expansion periods require higher funds than mature, stable companies with defined income streams. Business owners could analyze the business stage and the plans for growth and development and assess their current working capital positions. Gaps, if any, at this stage of assessment could be plugged with flexible working capital financing solutions from companies like Tata Capital that partner in its customers’ growth.
4. Additional factors:
Sometimes, unprecedented events such as the global pandemic, to quote a recent example, could lead to further demands. These demands could be to survive periods of insufficient revenue or additional funds to meet investment in safety equipment or for expansion opportunities that changing times present.
Since it is not
always possible to assess how much working capital you need to tide through
such times, small businesses must account for these unplanned requirements
through an additional line of credit. Working capital financing can ensure you
do not miss out on these growth opportunities.
Managing working capital financing
Optimal working
capital is essential for the business to grow and run smoothly. Suppose you
continuously face a shortage of working capital or keep excessive cash buffers
to meet unplanned operational expenses. It may be time to have a thorough look
at your cash flows and access working capital financing to plug the deficits
and invest surplus cash at higher returns.
A working capital loan provides businesses with a line of credit to access as and when needed to navigate a cash crunch. This access to capital allows businesses to operate continuously without interruptions in the short run. In the long run, optimizing working capital can help small enterprises stabilize financially, grow, and expand to their fullest potential.
The needs of every business are unique, and the working capital requirements vary across multiple business contexts. Reach out to your financial expert at Tata Capital to recommend the best working capital financing solution for your business.
20 November 2020
5 mins read
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