All You Need To Know About Working Capital Finance and How it Works

Business Finance

Many business owners believe that financing from banks and other lenders will always be the best option to fund business growth, but that is not always the case.

Working capital finance can help your company get the money it needs to meet immediate cash flow challenges. It also allows you to maintain your credit rating and keep control of your assets and debt repayment strategies. 

Learn more about working capital finance and whether or not it is right for you by reading this article on everything you need to know about working capital finance.

Defining working capital finance

Working capital is the money a company has available to cover its expenses between periods of sales. 

It can be used for day-to-day operations, long-term investments, or additional working capital loans. 

Working capital loan interest rate is one of the most important factors in determining how much you will pay in interest on your debt. 

A low working capital loan interest rate will result in a lower monthly payment, while a high one will lead to higher monthly payments and potentially a higher total cost of borrowing.

The primary factor that affects working capital loan interest rates is the length of time between when the funds are borrowed and when they are repaid. The longer it takes for repayment, the higher the rate.

Types of working capital

Working capital is the amount of money you have available at a given time. There are four types of working capital:

  1. Cash in hand: Cash in hand is the most liquid form of working capital finance. It can be put to use immediately.
  2. Accounts receivable: Accounts receivable show how much customers owe a company for products or services that have been delivered but not yet paid for.
  3. Inventory: Inventory stands for the products a company has on hand that are ready to be sold to its customers.
  4. Fixed Assets: The final type of working capital finance is fixed assets. This refers to items like property and equipment that the company owns and may utilise over time. 

How does working capital work?

Working capital is a type of business loan. Here, the finance company allows you to borrow up to 75% of what your inventory, receivables, and other assets are worth.

Working capital finance loans have an interest rate that varies depending on the financial strength of your company and what collateral you have for the loan.

They can be anywhere from 2% up to 7%. The borrower is required to repay the amount borrowed plus interest within 90 days, or it may face liquidation to pay back the debt.

As long as the borrower has some sort of collateral to offer (real estate, a vehicle, etc.), they will receive a lower interest rate than someone who doesn’t.

How to calculate working capital

The total value of all cash required plus all accounts payable is divided by 365 days in a year to calculate working capital finance.

Working capital formula: Current assets / Current liabilities = Working capital ratio

If you take out a working capital loan with an interest rate of 12% per year and make monthly payments, it would cost $200 each month to repay the balance at the end of one year.

A lower working capital loan interest rate could save you thousands of dollars over the life of your business. This depends on how much working capital you need and how long it takes to get repaid.

The importance of working capital management

Working capital is the difference between a company’s current assets and liabilities. The level of working capital needed varies based on the type of business. 

Companies need to manage their working capital levels because this has an impact on liquidity and solvency. This in turn can have a big effect on the company’s creditworthiness. 

Working capital finance is determined by several factors, including credit history, industry type, and the size of the company. There are some reasons why your business might require additional working capital:

  1. To fund new projects and equipment: The working capital loan interest rate is usually lower than the company’s credit card debt. So it can be a good way to help fund projects and equipment that will increase your revenue in the future.
  2. As a short-term solution for cash flow issues: Working capital loans are usually paid back in one year or less, so they’re an ideal short-term solution for companies with cash flow issues.
  3. To repay higher-interest debts: If you have more expensive debts such as a car loan, student loans, or credit cards, working capital loans can often save you money in the long run by getting rid of these debts.
  4. For inventory financing: If your inventory exceeds what you need on hand to fulfil orders, then you may want to look into inventory financing options. This provides additional liquidity for managing inventory levels during busy periods.

The working capital loan interest rate is typically lower than the company’s credit card debt, so it can be a good way to help fund projects and equipment. This will increase your revenue in the future. 

Working capital finance loans are usually paid back in one year or less, which makes them an ideal short-term solution for companies with cash flow issues.

The bottom line

Working capital is the fuel that powers a company. It is an amount of money that can be used for operations or investments. It helps keep the company operating and supplies it with working capital. Working capital loan interest rates are typically set at a fixed rate so that you know how much you will pay over time. Check out more finance-related articles at Piramal Finance on topics that interest you.