Working capital loans are hard to control. Your company’s ability to reach its business goals and maintain its stability depends on how you raise money. To get cash and improve the cash conversion cycle, you must optimise several areas. There can be a lot of mistakes made when you try to get more working capital loans (also known as net working capital, or NWC).
Here are some problems with working capital loans that could cost you your business if you don’t catch them right away and fix them:
Problems with Working Capital Loans
Poor production strategy
Suppose your business forecasting or production schedule is always wrong. In that case, your working capital loan will be used to pay for raw materials and manage and store the extra inventory, especially if you are making more than you can sell. This is one of the most common and expensive problems with working capital finance. Still, it can be avoided if you regularly check your sales estimate and make changes when necessary. This will allow you to change your purchasing and production plans to meet your business’s needs.
It could strain your working capital loan if you don’t pay close attention to the extra money you need for growth and expansion. You can borrow the money at a higher interest rate to keep the business running. If your expansion plans fail, they won’t bring in as much business as you thought they would.
Neglecting timely account receivables collection
Accounts receivable are the main way you get money for working capital. Your working capital loan interest rate could be high if you don’t have a good way to collect payments or if your clients don’t pay you on time. Accounts receivable are a weak spot for many businesses. Even though it looks like an asset on the balance sheet, it could quickly become a liability. Then the business needs to borrow money to keep running, even if the interest rate is high.
Extending a time of high credit
Businesses often extend the credit period longer than usual to get new customers, keep old customers, or keep an account active. For example, if they want more business, they can extend the standard length of credit from 30 days to 45 or 60 days. Even though you can’t completely avoid it, making it a habit or giving credit to all of your clients can hurt your cash flow. As a result, the interest rate on your working capital loan will go up.
Not getting a down payment for big orders
Large orders that rarely come need more money. In addition to buying more raw materials, businesses sometimes need to hire more people. They also need to buy more tools to fulfil large orders. If you can’t get a bank loan or an advance to pay for the extra cost, you’ll have to pay for it out of your operating capital. This could lead to a lack of money if big orders take longer than expected.
Getting working capital from suppliers
Businesses often ask their suppliers for longer credit terms to help them get through times when they don’t have enough money. For example, your vendor might give you a 30-day grace period, but you can’t pay on time because you’re running out of money. You want 10–15 more days to pay off the debt. Using vendors as a source of credit is a good way to get a working capital loan, but it comes at a cost. If you pay your vendors late, they might stop doing business with you. Vendors could refuse to give you credit, which would slow down delivery.
Neglecting short-term responsibilities and events
In addition to their payables to suppliers and vendors, companies may also have other short-term obligations like loan payments, lease renewals, and income taxes. All of these costs take money from the available working capital loan. When figuring out how much of a working capital loan the company needs, you must consider these short-term debts so that you don’t run out of money when the bill comes due. In the same way, you still need to save money for things you can’t plan for. For example, even though it can’t be predicted, transportation costs may go up because gas prices are going up or because workers will ask for pay raises or overtime pay. Putting money aside for these things is necessary to ensure they don’t get in the way of everyday business.
Letting suppliers and customers choose payment methods
Almost every business has paperwork to fill out when a new customer, supplier, or client comes on board. Even though the formats and ways of entering data are different, they all have the information needed to speed up the payment process. One common mistake is to ask for the payment plan you want and then accept it without looking into it. This is bad because it makes it hard for the buyer to negotiate payment terms or think they have already done so. Two, if the rule is set by accident that any payment term is fine, the team onboarding the new business may have to do a lot of extra work to keep track of them all. Last but not least, this strategy would affect working capital, even though it would save time at first.
Even though it’s hard to get a working capital loan, your company’s ability to reach its business goals and keep its finances stable depends on it. Cash needs to be made, and the cash conversion cycle (CCC) needs to be improved in many ways. Now you know everything you need to know about working capital loans. For more information, visit Piramal Finance.