How to determine your Working Capital Needs

 

One of the most discussed and difficult financial concepts as far as a small business owner has to understand and consider is the working capital. The term is often interpreted in different ways sometimes which could be demystifying, as the way to depict it in general terms differs in a matter of understanding it in principle. The business runs in the calculations on how in each period to analyze the working capital and how to meet them on a regular basis.

What is Operating Cycle

The operating cycle is useful in analyzing the accounts receivable, inventory, and accounts payable cycle in terms of days. The receivables are analyzed in terms of the needs of the business in terms of days; the inventory is calculated as the average number of days it takes to convert into a sale and the payable which is analyzed in terms of the number of days it takes to pay a supplier.

Many businesses cannot meet their financial requirements with the existing operating cycle with the receivables and payables alone; hence they may externally borrow or try to cover the shortfall with the profits generated.The requirement of short-term capital could arise due to seasonal nature of the business or a good demand for the products in the market due to the holiday season. Planning to fund in the short term requirement is essential to get an increased production and profitability, without getting caught off guard.

Sources of financing in Short term

  • Equity- borrowing form a third party, family or friend is a way out to meet the immediate fund requirements if the business is yet to make profits.
  • Creditors- sometimes the creditors extend their credit facilities in terms of a good and harmonious relation, to increase the credit period from the 30 days to a 60 days period to fulfill a big order, with or without a lien.
  • Short term loan-usually a one-time loan can be availed from banks to fund in to meet the working capital requirements to complete bulk and huge orders.
  • The line of Credit-this is usually availed by big businesses when they have a spread over the year with each loan taken once in 30-60 days period as and when the working capital requirement arises, with repayments start happening once the receivables are collected
  • Factoring is another way to meet the financial requirements of a business in the short term when the receivables are brought in by the financial institutions and all the sales amount collected are taken by the factoring finance company, which could be an expensive way out due to the high lending rates.

Procuring the funds to meet the requirements in the short term could be eased out if there is an efficient way to handle the cash conversion cycle and keep funds aside for business contingencies and expansion.