How to use Working Capital Loans to Create a Successful Business
Are you an entrepreneur? Do you aspire to build a great business? No matter what stage of the entrepreneurial journey you are in, working capital is one of the most vital elements to keep the organization moving ahead.
What is working capital?
For the uninitiated, working capital is the money required by a company to run its day-to-day operations. Companies that generate free cash flow are valued because of their ability to generate cash to run their operations without external help or funding. However, all businesses are not alike. While some generate recurring free cash, others operate in businesses that are cyclical in nature. They go through peak seasons and slack seasons. They experience crests and troughs with respect to working capital.
Working capital Loans
For businesses that are cyclical in nature, working capital financing enables them to tide through tough periods. € 1.3 trillion cash opportunity could be released by ensuring better management of working capital as per a PwC report. Companies, especially Small and Medium Businesses (SMBs), are using working capital loans successfully to tide through tough times. They do realize the opportunity of having cash in hand during critical times. Even in low business phases, SMBs have leveraged business opportunities by resorting to working capital loans.
How do companies use such loans for success in business?
A comfortable working capital situation enables businesses to hire better, pay salaries on time, and take on more orders or contracts. It can also help the owners of SMBs to negotiate better terms with vendors and suppliers.
Most importantly, these loans can ensure that companies are ready to tap all opportunities. The opportunity could be an expected one or it could have resulted from a macro/ policy level change.
Business owners, especially the ones running SMBs use working capital loans to augment business growth and leverage opportunities that arise when cash flows are not as seamless.
A few ways in which they use this type of loan to enable their businesses to
succeed is as below:
Managing Cash and Payments: When a company pays its stakeholders on time, it builds a great brand. Promoters of SMBs are focused on scaling the business and building great brands. Working capital loans enable them to undertake some important activities that enable them to create a robust brand. These activities include paying the employees on time, ensuring that the infrastructure and amenities are up and running for business to function as usual, and for paying vendors or honoring lease agreements to maintain credibility.
Manage Delay in Receivables: It is not uncommon for small and medium businesses (SMBs) to experience delay in payments. With a limited set of customers and not a high proportion of recurring periodic revenues, working capital loans for small businesses comes in handy to manage a slack in cash flow due to increase in receivables.
Ensure Timely Purchase, Upgrades, and Maintenance: SMBs will often have an ad-hoc method of managing purchases, upgradation of systems, and management of maintenance schedules. Working capital loans are extremely useful when the business wants to replenish stock to cater to unexpected rise in demand or buy additional inventory to fulfil such demand. Companies may also use such loans to cater to an unexpected order with very good payment terms (a good ratio of advance payments to the total). This enables them to generate good cash flows and create a better cash flow position for the future.
Launch Marketing Campaigns: Businesses looking to attract new clients, rejuvenate their brand, or increase their online presence can use working capital loans to launch a new marketing campaign or expand an existing one. Advertising, participation in events through sponsorship, direct marketing campaigns, billboards, social media campaigns etc. are among the common uses of this type of loan.
Digitization, Expansion, Business Development, Facilities upgrade: Digitization and growth hacking through a mobile interface are the order of the day. Even SMBs are leveraging digital platforms, “as-a-service” models etc. to convert large CAPEX cost into an OPEX model. Working capital loans would help companies to quickly adopt a new technology. It could be building a mobile app and leveraging the power of push notifications to reach out to customers. It may also be about reducing the spends towards IT infrastructure and applications by moving them to Cloud.
For companies which aren’t so heavily reliant on technology, these loans could be a great way to raise funds for business expansion. It could mean completion of the work on a plant at their manufacturing unit that could enhance overall efficiency by a good number. These loans are also used by companies to open a new office location that might help them to accentuate its business.
The SMB business owners could also use working capital loans for consulting and technology expertise to upgrade their technology systems, usher in automation and reduce the constant recurring cost to garner cash flow benefits in the future. They could also use it to pay taxes on time. The owners of small businesses can clear off the remaining tax liabilities before closing their book for the year.
As per a survey of bankers, nearly 17% of the SMBs and businesses use working capital loans to finance their receivables. 19% of the bankers said that it could be used for purchasing equipment or upgrading infrastructure. 20% of the respondents said that companies used such loans to build new facilities and to expand their existing ones.
To sum up, working capital loans should not be looked at as only a liability. It can ensure that SMBs can tap into a unique and rare business opportunity instantly and boost growth. It can also enable them to hire external consulting or expertise to augment their strategies, systems, and operations to grow further. Most importantly, it can ensure that their employees, vendors, and other stakeholders are paid on time. It helps SMBs to remain creditworthy and raise money at better rates when they need it. The result is that the future cash flows can be managed better, and the SMB owners can focus on core business operations to ensure business success.
A good credit score arising out of the creditworthiness and the habit of paying on time can help the business when they decide to raise capital through a stake sale. A robust business which has a good credit score often has the probability of getting more value when they raise capital through the equity route. Hence, working capital loans are a means to not only address present cash crunches but also create a brand that can itself be better valued.