Working capital creates the means for businesses to run and grow. Without it, businesses would collapse quickly. But what is working capital? It is the difference between your business’s revenue (income) and expenses. As an equation, it would look like this: revenue - expenses = working capital. It is used for your business’s day-to-day operations, such as paying employees, paying for inventory, and updating products or technology.
There are two subcategories of working capital: long-term working capital and short-term working capital. Because long-term working capital is more stable and predictable than short-term working capital is, it can be easier to plan for long-term expenses like paying your employees or keeping up your inventory. Short-term working capital, on the other hand, covers the cost of unexpected or irregular payments that your business doesn’t have to make often. Knowing the sources of working capital available to you when these expenses arise will help keep your business afloat and give you enough money to cover those costs while maintaining your long-term working capital.
Short-term working capital consists of the assets you use to pay for short-term expenses or other unexpected events. These may be natural disasters, a technology crash, or an increase in inflation. Think of short-term working capital as your rainy day fund.
To find what money you have available to use as your short-term working capital, you will first have to find your net working capital. To calculate it, find the difference between your assets (what your business owns that can be converted to cash if necessary) and your liabilities (your financial obligations). As an equation, it would look like this: assets - liabilities = net working capital. Once you find your net working capital, you will then subtract your long-term working capital from the net working capital to get your short-term working capital (net working capital - long-term working capital = short-term working capital).
If you calculate your short-term working capital and find that your business doesn’t have enough to cover the costs of your short-term expenses, you may want to consider finding other sources to help cover the costs.
There are several short-term sources of capital for you to choose from when the need arises, including banks, credit unions, SBA loans, trade credit, and government aid. Below is more detail about each type.
Banks are the most widely known source of short-term working capital. They offer it in the form of loans, credit, overdrafts, and discounts on bills of exchange.
Loans: To get a loan, banks will look at your credit score, collateral, your business’s financial history, and your business plan.
Credit: You may elect to use a company credit card to pay for the short-term expenses before you actually have that money. The bank will tell you what your credit limit is. In some instances, they may let you spend over that limit (overdraft) with interest.
Discount of Bills of Exchange: A bill of exchange is a plan you set up with another business to pay you back over a set period of time for something you gave them. If you have one of these, you can sell it to the bank. After the bank deducts interest from the bill, they will give you whatever money is left of the bill. They will then be the ones receiving the money that the other business needs to pay back.
The pros of using a bank include building your credit and being sure that you’ll get the money you need to cover your short-term expenses. The cons are long-term repayment plans with interest and the bank taking a while to actually get you the money you need.
Like banks, credit unions offer loans and credit cards for those who are members. Interest rates and fees on these types of lending are typically lower than on those offered through banks, but you have fewer options to choose from than you would have had you elected to get one through a bank. For this reason, this option would be best if you do not plan on needing many loans. When considering this option, make sure that you meet the requirements of membership to join the credit union. Some of these requirements may include either working for a certain employer, having a family member who is a part of the credit union, or living in a certain area.
The Small Business Association (SBA) offers loans as high as $50,000 to small businesses trying to start up or expand. The average loan amount that small businesses receive is $13,000. The funds from the Small Business Association will go to an intermediary lender who will then provide your business with the loan. These loans cannot be used to pay off debts or to purchase real estate.
Also known as mercantile credit, trade credit is when the company that your business is buying a product or service from allows you to pay for that product or service at a later date determined by the seller. Typically, the seller will give you somewhere between 30-90 days to pay them back for it.
Whether a company decides to give you a trade credit, and how much they give it to you for, depends on several factors, including
Your business’s reputation
The seller’s financial standing
How much you purchase
The amount of competition within the market
Many companies will offer discounts on products or services if your business pays them back quicker than agreed upon.
The US Department of the Treasury also offers aid to small businesses. They offer it through:
Small Business Tax Credit Programs: These programs offer tax benefits, particularly in the areas of employee retention and paid leave, to small businesses.
Emergency Capital Investment Program: This program gives low- and moderate-income community financial institutions the money to support small businesses and consumers in their areas.
Paycheck Protection Program: This program gives small businesses financial resources to maintain their payroll and hire back employees who may have been laid off. This includes the money needed to cover benefits for up to eight weeks. The funds given through this program can also be used to pay interest on mortgages, rent, and utilities.
Some of the above-mentioned sources of short-term working capital can be good choices, but not always. What do you do if you need that money immediately? The sources above require an extensive application process before you’re even approved. That’s where Backd comes in. Backd is a form of alternative financing with an application process of ten minutes or less and can get you up to $750,000 within 24 hours. Tell our team what you need, and we will find the best solution for you. We also let you create a repayment plan on your own terms. If something comes up, let us know, and we will adjust your repayment schedule.
To learn more about our working capital options, click here.