When you start your own business, and don’t come from a finance or accounting background, there are certain terms that you must learn and working capital is one of them.
What is it exactly? Let’s take a look…
Working Capital can be understood as the measurement of the operating liquidity of a company.
Why is important?
This is important as it allows startups to:
- Increase their share value
- Meet short-term debts
- Pay expenses
Working Capital is essential acts as the lifeline of the company when there are limited options for startups to finance themselves and move past their breakeven point. It is a measuring tool that gives insights into a company’s financial structure.
The five sources that startups use to procure working capital are:
1. Utilising venture capital: With Venture Capital funds, you are assured a sizeable investment and the best mentorship in the business. This enable you to plan how you can scale your business. Venture Capital is best suited for small businesses that are looking at expansive growth. Though VCs look to help your company grow, they also look to capitalise on their investments.
2. Raising equity: A good way for your business to become profitable is through issuance of equity and short-term working capital funds. When your personal finances diminish, equity shares will create the required capital necessary to help your business grow. You need to determine the rate of dividend per share based on the profits earned. This allows a business to reduce their financial burden but you will need to give up some company ownership.
3. Discounting Bills of Exchange: When your goods are sold on credit, you can draw a bill of exchange for goods that are sold. These bills of exchange include the acceptance by the buyer to clear the bill on the date of maturity. Your firm can discount these bills of exchange with a commercial bank for a bank discount. This will help you raise finances when payments are due for a cost against the bill of exchange that you make with the bank.
4. Acquiring short-term notes: When you establish a good relationship your bank and they are willing to provide you with a short-term note based on inventory, orders and future receivables. This is undertaken by the bank against a guarantee that is issued by the borrower against a collateral for business needs only.
5. Building a line of credit: Most banks do on not offer a line of credit to new entrants but exceptions are made for businesses with a good equity and sound collaterals. A line of credit provides startups the funds needed for short-term needs. These funds are repaid when the accounts receivables have been collected.
The benefits of having a sound working capital strategy is that banks provide funding based on assets that will be purchased and expenses that would be covered. Letters of credit are given as a guarantee for non-funded facilities that are made on credit and available in the local and foreign currencies. By having a sound command over your working capital, you can control your operating expenses, purchasing inventory, receivables financing, either by direct funding or by issuing letter of credit and other similar instruments.