Working capital or the Net Working Capital (NWC) is the capital used to meet the day-to-day trading operations of a company. It is calculated as the difference between current assets (e.g. cash accounts receivable) and current liabilities (e.g. accounts payable).
If the ratio of current assets to liabilities is less than one, then the company has a negative working capital. This indicates that the company might face difficulties in growing or paying back its creditors. In the worst case scenario, the company can even go bankrupt if the current assets continuously fail to exceed the current liabilities.
If the ratio of current assets to liabilities is greater than one, then the company has a positive working capital. This indicates that the company can bear the expenses of its current expenditures and can invest in future activities and projects. Thus, it is crucial for companies to maintain a positive working capital.
New Sources for Working Capital for SMBs
Companies may maintain a positive working capital if they have access to multiple reliable funding sources. Here are a few of such sources that could help you meet your working capital requirements:
1. Issuing Shares (Equity and Preference Shares)
One of the most common methods to raise long-term funds for your business is issuing shares. This funding method is trusted and used by most of the companies. Shares are units of fixed value of the company’s capital that are issued to shareholders who receive a dividend in return for their investment in the company. Preference shares and equity shares are the two types of commonly issued shares. Here are few features of issuing preference shares:
No obligation to pay dividend as dividend is only payable if there are visible profits
It serves as a permanent capital source for the company
No need to create extra charge on the company’s assets
Allows flexible repayment of capital in case of surplus funds
Since the shareholders do not carry any voting right, they have no say in dilution of control
Cannot be considered as a deductible expense
Becomes a permanent burden so far as the payment of dividend is concerned
An expensive source of finance if compared to other funding solutions, such as debentures
Features of equity shares:
No obligation to pay a fixed dividend to shareholders
Can help strengthen the company’s financial base
Allows inclusion of members since individual shares have a small face value
Shareholders can vote in matters that require consent of shareholders
Can assist in capital formation since they serve as a permanent source of income
Uncertainty of return can demotivate investors
Companies issue debentures as an evidence of any debt that is due from the company. Here are a few features of debentures:
Can provide funds to the company for a longer duration
Enables company to leverage equity shares in a better way
Lower interest rates than dividend payable on shares
Helps reduce tax burden as interest on debentures is a tax deductible expense
No risk of control dilution since holders do not have voting rights
Can be easily redeemed by company when the funds are surplus
Can turn out to be a permanent burden on the company as interest rates are fixed
Heavy stamp duty increases the cost of raising debentures
Not a suitable mode of funding for companies with unstable incomes
3. Crowd Funding
Crowd funding is a fund-raising method that allows the public to deposit funds for the companies. Here are a few features of crowd funding:
Can serve as a cheaper method of fund-raising for shorter terms
Follows a very simple and convenient method
Does not require creation of any charge on assets
Fixed interest rates and maturity period allows taking advantage of trading on equity
Limited funds can be sourced
Unreliable source of finance
Shorter maturity periods
4. Reinvesting Profits
Reinvesting profits is a technique used by companies that involves retaining a certain amount of profits for reinvesting them back in the company. Here are a few features:
Economical funding option since it does not involve any extra expenditure
Reduces uncertainty and ensures flexibility because the company is not dependent on any outside source for raising the fund
Enables a stable dividend policy
Helps redeem long-term debentures and loans
Can deprive shareholders of their freedom to reinvest in better opportunities
5. Taking Loans from Private Moneylenders
Private moneylenders or indigenous bankers have been serving as the one of the sources of finance for generations in our country. While the rise of commercial banks may have somewhat overshadowed these moneylenders, they can still serve as a funding solution for meeting short-term requirements.
6. Securing Trade Credit
Securing trade credit refers to taking goods or other needed materials from suppliers on credit. This mode of funding for working capital can serve as an important source of short-term finance. Since it provides interest-free capital, this funding method can be leveraged efficiently by businesses to gain maximum benefit out of it. However, since credit worthiness and goodwill forms the basis of this arrangement, it can at times turn out to be unreliable.
7. Taking Loans from Commercial and Government Banks
Commercial and government banks are now the main funding source for a lot of companies to secure capital. Banks provide an advance in return for security, to companies for their business growth, subject to special requirements of every bank. You may avail this facility and solve your funding requirements by applying for loans, cash credit, overdrafts and discounting bill of exchange. You can also make use of government initiatives and schemes that are launched and are in action, and that you are eligible for to provide funding solutions for small and medium businesses.
8. Taking goods from suppliers on Instalment credit
In this method, goods are secured in advance but payments are cleared later in instalments. Usually, an interest rate is charged on the unpaid amount for a predetermined period of time.
9. Taking an Advance from Clients (Deferred Incomes)
Companies can also take an advance payment (deferred incomes) from their clients before completing the order. This can easily help them cover their day-to-day expenses and serve as a short-term financing solution.
10. Selling Unwanted Assets
Another way of raising funds for maintaining a positive working capital is to sell off unwanted capital assets to meet bigger financial needs. The only drawback of this method of securing funds is that you can no longer enjoy the benefits that were being provided by those assets.
There are numerous financial funding solutions to maintain your working capital requirements. All that you need to do is choose the most suited one and further your business journey.
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