Your guide to working capital finance

Struggling to balance the working capital at your business?

From seasonal fluctuations to increased expenses, many factors can throw off your asset-to-liability ratio, causing your working capital to diminish. Luckily, working capital finance solutions offer you convenient access to crucial funds that can help maintain your day-to-day operations. 

What is working capital?

Working capital, also known as net working capital, is a metric many businesses use to assess their current short-term financial health. It’s calculated by subtracting your current liabilities from your current assets, as in, anything you can gain liquid access to within the next year minus anything you will need to pay in the next year.

Working capital glossary

Here are some terms you may encounter as you get to grips with working capital and its related financial options: 

• Current assets: While assets are anything owned by the company that will provide value over the next year (eg a car, a house, cash, money owed to the business), current assets are more specific. They are any assets that could be turned to liquid cash within the next year. Net current assets or short-term assets are two other terms used to describe this. 

• Current liabilities: These are any debts or outgoings that you must pay within the next year. Short-term debt or short-term liabilities are two other ways to say this. 

• Working capital cycle: Also written as WCC, your working capital cycle is how long it would take your business to turn your current assets and current liabilities into cash. Essentially, if you purchase stock, the invoice from your supplier is a liability and the stock could count as an asset, but the stock isn’t cash. Consider how long it would take you to go from there to the customer purchasing that stock and handing over the funds. The longer this cycle is, the more strained your working capital may be. 

• Finished goods: This is anything that exists in its final form but has not yet been sold onto a customer. For example, let’s say you manufacture motorbikes. A completed bike that’s sitting in the warehouse or shop floor would be a finished good. 

• Accounts payable: Your accounts payable is what you owe your suppliers. It’s considered a liability. An example would be an invoice your lightbulb supplier sent you that you haven’t gotten around to paying yet. 

• Balance sheet: A balance sheet helps you gain a better understanding of your company’s financial health. It includes all assets, liabilities, and equity. 

• Operating expense: This is what it costs you to run the business as usual. 

• Inventory turnover: This is how quickly your business sells and replaces its inventory. 

Why does working capital matter?

Positive working capital means you have more liquid assets than liabilities, which means you may be able to use some of those assets to facilitate growth. In a nutshell, it means there may be extra cash in your business that you can use to fund marketing or expansion activities.

Negative working capital means you owe more than you have, which can result in your business falling into debt, missing payments, being unable to pay suppliers and employees, or even defaulting on a loan.

It’s important for businesses to understand which camp they’re in so they can make the necessary arrangements – expansion if they have positive working capital, or, increasing income or reducing expenses if they have negative working capital.

The working capital formula

Before you can determine your funding needs, you need clear oversight of your current working capital.

To calculate your working capital, subtract your current liabilities from your current assets. Your working capital assets to liabilities ratio should fall between 1.2 to 2.0. A ratio below a 1.0 can indicate cash flow problems to your accounting team and investors.

For example, if you have £5,000 in the bank, a customer that owes you £4,000, an invoice from a supplier payable for £2,000, and a VAT bill worth £4,000, your working capital would be £3,000.

Here’s a breakdown of that equation:  

Assets (5,000 + 4,000) – Liabilities (2,000 + 4,000) = Working Capital 3,000

Tips for managing your working capital

• Keep a budget: Keeping a monthly budget that tracks all income and expenses can help you ensure your business always has enough capital to meet its short term obligations.

• Review your expenses: Consider if there are any areas you can save in, for instance, you may be able to negotiate with your suppliers for better rates or there might be expenses you could cut out all together.

• Upsell and cross-sell: 37% of sales people avoid upselling, but of the sales people who do engage in upselling, they make an average 30% more in revenue. Not only that, but upselling can boost customer lifetime value by 20-40%. Both cash and unpaid invoices count as assets, so if yours are dwindling, consider upselling and cross-selling.

• Emergency fund: A company emergency fund can help ensure you still have the funds to meet your obligations even if your working capital needs a little smoothing out from time to time.

• Chase invoices: 2 million British SMEs were paid late last year, according to NatWest. Late payment can have a significant impact on working capital. If possible, follow up on any invoices once they become due.

Why working capital isn’t the only marker of financial business health

Working capital provides an in-the-moment snapshot of your business’s financial health, but it doesn’t dive into your ability to manage cash flow long term, your projected income, or your profitability.

Not to mention, let’s say you spent an unprecedented amount on inventory last month – your working capital may be negative but that doesn’t necessarily mean it won’t settle out into positive in the upcoming months. Working capital also doesn’t take into consideration your potential for growth, your ROI, or how much debt you may have.

Ultimately, while working capital can help you understand where you’re positioned as far as short-term liquidity, a more complete financial picture is required when making long-term impactful business decisions.

Understanding working capital finance

Working capital finance refers to business financing designed to cover your short-term operational expenses. Oftentimes, businesses leverage working capital finance to fund specific growth projects, for example, major contracts or expansion into new markets.

With a working capital finance solution, your business can bridge the gap between your short-term funding and your operational efficiency. Working capital finance enables you to maintain a steady cash flow so you can seize growth opportunities when they arise and navigate financial fluctuations with ease. 

Do I need working capital finance?

Whether or not you need working capital finance depends a lot on your current financial health. If you’re struggling with negative working capital, this type of finance might be suitable to you. 

Ask yourself:

• Is my working capital positive or negative?

• Can I pay my suppliers, employees, and loans next month?

• Am I capable of repaying any finance I receive?

• Do I need to add new hires or purchase any new equipment to support an upcoming busy period?

• Is there an opportunity I want to take advantage of that I simply don’t have the cash for today, but I will have the cash for once the deal is finalised?

• Have I had to turn down any business recently because I haven’t had the funds to support the project?

Example: Let’s say you run a fancy dress store. Your biggest seasons are Easter, Halloween, and Christmas. In September, you don’t have the funds to purchase your inventory in advance of Halloween. By 3 November, you’ll have everything you need, but by then it will be too late and you’ll have missed out on the sales. In this instance, working capital could help you purchase the required stock to help you manage this seasonal variation.

Types of working capital finance

• Working capital loans: Working capital loans often span a short term and help boost your immediate cash flow. The amount of a working capital loan depends on your financial needs and your business’s creditworthiness. Secured working capital loans require you to put assets up as security, while unsecured business loans don’t require security but do usually require a better credit rating. 

• Overdrafts: Business overdrafts are financial agreements that enable you to withdraw more money than is available within an approved limit. While obtaining a business overdraft via a traditional bank can be difficult, plenty of alternative finance providers offer flexible business overdraft solutions. However, keep in mind that business overdrafts often have low credit limits. 

• Revolving credit facilities: A revolving credit facility is a flexible financing arrangement that offers a predetermined credit limit similar to a business credit card, with interest charged only on the amount utilised. Revolving credit facilities don’t require a specific bank account with the provider, allowing you to direct the money where you need it. 

• Invoice finance: If you offer credit terms to your customers, invoice finance could be a suitable way of unlocking working capital in the short term. The amount you borrow is, by definition, limited by the value already owed to you via customer invoices, making this a good option for increasing cash flow but not necessarily the right option if you require a significant amount of funding. Keep in mind that invoice finance is only as good as the strength of your debtors, customers will have to change the account they pay into, and it can be admin heavy.

• Trade finance and supply chain finance: Both trade and supply chain finance are designed for businesses that focus on physical stock rather than services rendered. Supply chain finance allows buyers to delay payment while suppliers get immediate payments from lenders. Trade finance is more complex, facilitating international trade and often involves prepayment arrangements. 

• Asset refinancing: Asset refinancing – also known as asset-based lending or asset-backed financing – uses the value of an existing asset, such as equipment, property, or accounts receivable, as collateral to secure a loan or line of credit. If you can’t get enough funding via an unsecured business loan, asset refinancing could be a suitable option to gain more funds. Asset finance typically requires an upfront deposit and there is less flexibility with early repayments.

• Merchant cash advances: A merchant cash advance provides you with a lump sum of capital upfront in exchange for a percentage of future credit card sales or daily bank account deposits. If your business accepts payment from customers using card terminals, a merchant cash advance is one way to increase working capital. 

Tax bill and VAT funding

 If your tax bill is straining your working capital, there is funding available specifically designed for paying VAT or corporation tax. Getting a loan for your tax bill allows you to spread the costs over 3 to 12 months, providing you with increased cash to cover other operational expenses. 

What can I use working capital finance for?

• Short-term expenses: You can use working capital finance to bridge the gap between receiving payment from customers and making payment for monthly costs like payroll, rent, or inventory. 

• Seasonal variations: Working capital finance can help improve cash flow, for example, if you are a retail business, you might use this type of financing to stock up on inventory in advance of a busy period. 

• Growth: If a growth opportunity surfaces, such as the ability to take on a bigger project or the chance to expand into a new market, you can use working capital finance to facilitate this. 

Who should use working capital finance?

Different businesses require different amounts of working capital based on their individual expenses, assets, and liabilities. For instance, a retail business requires lots of available cash for purchasing inventory and maintaining a storefront, while a tech company operating remotely might not have the same regular costs. 

Ultimately, determining if you need working capital finance comes down to your working capital balance. If you find your liabilities often outweigh your assets, you might need a working capital boost. 

How to apply for working capital finance in the UK

At Funding Options by Tide, we help businesses gain the working capital they need to thrive by matching eligible borrowers to our network of over 120 lenders, allowing them to compare different loans and financing options to find the best solution for your business.  

Find out if you’re eligible today.

Please note that the information above is not intended to be financial advice. You should seek independent financial advice before making any decisions about your financial future.

It’s important to remember that all loans and credit agreements come with risks. These risks include non-payment and late-payment of the agreed repayment plan, which could affect your business credit score and impact your ability to find future funding. Always read the terms and conditions of every loan or credit agreement before you proceed. Contact us for support if you ever face difficulties making your repayments.

Funding Options, now part of Tide, helps UK firms access business finance, working directly with businesses and their trusted advisors. Funding Options are a credit broker and do not provide loans directly. All finance and quotes are subject to status and income. Applicants must be aged 18 and over and terms and conditions apply. Guarantees and Indemnities may be required. Funding Options can introduce applicants to a number of providers based on the applicants' circumstances and creditworthiness. Funding Options will receive a commission or finder’s fee for effecting such finance introductions.