Struggling to manage funds for your business & don’t know which types of working capital would be best for you? If so, you’ve just landed at the right place.
It is quite obvious that running a business is no piece of the cake. You have to manage a ton of things together. You have employees to manage, investments to make, and draw profits at the end of the day. The slightest slip can break down your entire empire.
With that in mind, have you thought about the most crucial element behind all these?
Yes, you have guessed it right. It’s the working capital, aka the funds you need to run your day-to-day business. It may include rent, debt repayments, payroll, and whatnot.
Now, I guess you know that it is possible to apply for working capital loans if you are facing a shortage of funds. These loans can help you carry on your business. Keep scrolling to learn how!
Also, we will be learning about the types of working capital management today. So, let’s dig in…
What is Working Capital?
It reflects the liquidity available to manage your daily business operations. For starters, the current liabilities are subtracted from current assets to determine working capital.
A company works hard to have positive working capital. A lack of working capital shows a business’s inability to meet short-term responsibilities. This might affect operations negatively.
So, managing working capital is crucial for maintaining sufficient funds. It should neither be excessive nor insufficient.
Types of Working Capital/Management
These are the different types of working capital available in India. Have a look-
Permanent Working Capital
It is also known as fixed working capital. This is the fund that a company plans to maintain in-hand year after year. A small amount of working capital is needed to meet all current liabilities. It also helps in maintaining the smooth functioning of your firm.
Permanent capital is seen to be of utmost importance to enterprises. The size of permanent working capital varies with the relative size of the firm. It must be increased as the size of the business expands.
Lower fixed capital denotes a firm with less financial flexibility and operational effectiveness.
Consistent Working Capital
It is the least amount of capital your company needs. This helps to finance its day-to-day operations.
For instance, this capital can cover your costs incurred to process raw materials, operational costs, etc.
Variable Working capital
It is the extra working capital set aside to meet any sudden increase in demand.
Reserve Margin Capital Working
It is the extra money that your firm has in hand. Note that this capital is in addition to your regular working capital.
You may use it to cover unanticipated situations like natural disasters, equipment failure, or property damage.
Seasonal Variable Working Capital
As the name implies, this is extra money set aside to cover the year’s high season demand. To satisfy such high seasonal capital needs, this can be a boon.
What are Working Capital loans?
It is a loan that you can use to fund your daily business-oriented activities. A business doesn’t always have consistent sales throughout the year. You may occasionally require money to fund your operations. This is where working capital loans come to the rescue!
Working capital loans are available from banks and other non-banking financial institutions. They assist you in covering your operating costs during this time of low sales and revenue. Such a loan is crucial for businesses that experience seasonal business cycles.
It can also be necessary for cyclical sales during decreased company activity. So, it mostly depends on the loan size and the financial health of your business.
You may or may not need to put up collateral to get one of these loans. Read for more detailed information on working capital loans
Types of Working Capital Loans
There are different types of working capital loans available in the market.
Short-term loan
If you are getting a short-term loan, you must know it has a fixed interest rate and payment schedule. Note that these loans are secured.
Bank overdraft facility or credit line
This is one of the most flexible working capital loans you will come across. In this, the lender permits you to utilize a specific amount. You must take care not to spend more than the amount approved.
Trade Credit
When you place a large order with a supplier, they will offer you a trade credit. However, the provider will only approve this loan after carefully reviewing a bunch of things. It would be your creditworthiness, earnings, and credit history.
Account Receivables
You can use your verified sales, orders, or accounts receivable to apply for a loan. It is perfect if a business lacks the resources to fulfill a sales order.
But, these loans are only secured if your business has a solid reputation. Also, your business should have a robust track record of making on-time debt payments.
Bank Guarantee
It is a working capital loan without a fund basis. You can get a bank guarantee to balance the potential risk. It could be the risk associated with the failure to fulfill a specific agreement.
Working Capital Cycle: What is it?
The working capital cycle measures the time between when cash is collected from a customer and when it is paid out to suppliers.
The working capital cycle can be used as a measure of how efficiently a firm manages its cash. It can also indicate the company’s ability to pay its bills on time. The higher the working capital cycle, the more efficient the company’s cash management.
How to Calculate Working Capital Cycle?
To calculate the working capital cycle, you will need the following information:
- Accounts receivable turnover ratio
- Inventory turnover ratio
- Payables turnover ratio
Once you have this information, you can calculate the working capital cycle by using the following formula:
Working capital cycle = (Accounts receivable turnover ratio + Inventory turnover ratio) – Payables turnover ratio.
Then, the working capital cycle can be calculated by adding the accounts receivable and inventory turnover ratios. The payables turnover ratio then needs to be subtracted from the result.
Once done, you will know the number of days it takes for a company to generate cash and use that cash to pay for its expenses.
For example, let’s say that a company has accounts receivable turnover ratio of 4, an inventory turnover ratio of 8, and a payables turnover ratio of 2.
Now, using the above formula, let’s calculate the working capital cycle ratio:
Working capital cycle = (4 + 8) – 2 = 12 – 2 = 10
So, we can say that it takes the company 10 days to turn its working capital over.
Wrapping Up
I am pretty sure by now you have a good understanding of the different working capitals. If so, then you can easily apply for a working capital loan when in need. It will help you to meet the day-to-day business without breaking a sweat.
Working capital loans are generally provided at reasonable interest rates. Also, they have a short tenure of maybe 12 months. All in all, it is a very good option in case your business is facing financial restraints.
Now, if you’re looking for working capital loans online, do not forget to check Indifi for the best interest rates and easy processing.