For most businesses, a common challenge is the efficient management of the company’s working capital. The cause may vary, but most times the customer just doesn’t pay on time. Be that as it may, an effective strategy to answer this problem is through the financing of the working capital.
Working Capital Financing Basics
You wouldn’t be using these loans to purchase assets or investments. Compared to the usual loans, a working capital loan is meant to address the short-term needs of the company’s operating expenses. That means company expenses such as payroll and rent can be paid for by the loan.
The reason these loans exist is that sometimes, a company will have a hard time keeping up with all these operational expenses due to varying reasons. As mentioned above, most cases are attributed to delayed payments on the customer’s part.
This usually applies to companies whose business relies on particular seasons or cycles. With that in mind, you can imagine how many of these sales are paid in installments or are paid at the end of a certain period.
Generally, there will be methods or strategies when discussing working capital management:
This strategy aims to give your company the best chance for profitability but at the cost of higher risk. Short-term funds will be financing your temporary capital and what expenses are left for the permanent working capital. Your permanent working capital should, as much as possible, be addressed by long-term funds.
On the opposite end of the spectrum, a conservative approach will be the least risky strategy for capital management. Loans done under this strategy are often set with longer terms and, as a result, are often attached to higher interest rates.
This strategy will have the least liquidity risk but will also have the lowest chance of yielding rapid growth numbers.