Sometimes a business has cash-flow problems even though it is doing extremely well. There are a number of valid business reasons why this could happen e.g. the business is unable to access cash because it has to wait for payment of large orders (sometimes for up to 90 days). It is at times like these that access to working capital is helpful.
Applying for finance always needs to be carefully thought out because you will have to pay back the amount you borrow, plus a substantial amount of interest. In other words, it costs to raise finance. Therefore, if you need money to finance the day-to-day operations of your business (working capital), then you need to have a really good business reason for why your cash flow is so bad.
When to raise working capital
The following situations are good examples of when you should consider raising working capital:
- You have completed a large order but will only be paid in a couple of months’ time, and the client is a reputable company, so you know you will get your money. Providing you have a signed contract for the work, most lenders would consider providing working capital.
- You have a large contract and need to buy supplies in order to complete the job, but do not have the finances to do so. Once again, lenders will want to see a signed contract, and they also prefer that your client is a well-known company (this lessens the risk that the client will not pay you for the work).
When to be wary of raising working capital
It is important to bear in mind that lenders are in the business of earning money from the amounts they lend. Therefore, they are not interested in lending money to companies if there is a high risk that the company will not be able to afford to repay them.
Below are a few situations that are not suited to raising finance:
- You have completed the work, but the client hasn’t paid you and is making all sorts of excuses about payment. There is a risk that you may not get paid at all.
- Your business has unsteady income and you have run out of cash.
It pays to analyse your business honestly, and if need be, find a trusted outsider to do this for you, before you pour more money into a business that might not survive. You need to be sure that this is just a temporary glitch and your business will soon be on its feet again.
Match the loan to the period of finance shortage
Once you’ve decided that a loan is worth the risk, the next key step is to minimise the amount of interest you have to pay. If you have a short-term need, take out a short-term loan. The same goes for a long-term need i.e. a long-term loan would work best. This is the most cost-effective solution. Also consider whether this situation is likely to arise again and if so, consider finance options that enable you to access extra finance during these periods. Revolving credit or overdraft facilities could help here.
What are your options?
Here is a list of different financial options you can use to access finance for working capital: