What Is Working Capital Financing?

Bankers regularly characterize working capital as an important measure of the health of a company. Working capital represents the amount of cash and cash equivalents that are available for regular functioning of the business. Because of the delay between delivering product and the receipt of payment, there is often a need for cash financing. Thus, loans guaranteed by working capital are a ready source of cash.

What is Working Capital?

Working capital is that portion of a company's balance sheet used for day-to-day operations. Working capital is current assets minus current liabilities. Working capital is absolutely essential for the growth of a company. From working capital ordinary bills are paid and payroll met. Banks and other lending companies regularly grant loans to growing companies that are guaranteed by the cash flow of the company.

Financing Techniques

Financing working capital may take many forms. The lending institution is looking for assets that are constantly refreshed and have a high likelihood of payment. One source of working capital financing is a claim against receivables. Receivables are billings for work completed for clients for which payment has not yet been received. Receivable financing is the most common form of financing available.

Uses of Working Capital Financing

Companies that use working capital financing use the monies for one of three purposes: to cover seasonal low points in cash flow, to use the proceeds to grow the business and to pay bills for ordinary expenses. Using working capital financing for long-term financing would not be an appropriate use of proceeds. The repayment schedule must have the same time frame as the use of the proceeds.

Financing Terms

Bank lending is based on the credit quality of the borrower and the quality of the receivables. Receivables from Fortune 500 companies can be borrowed by up to 5 percent or more. Receivables from small private companies may yield only 60 percent. Banks usually charge an annual fee and a rate above prime for the total amount of dollars outstanding each month. Banks also analyze the number and quality of receivables.

Quality of Receivables is Important

Receivables for only one or two customized pieces of work are not as attractive as the receivables for hundreds or thousands of small amounts. Banks consider working capital a measure of the health of a company. If a company is borrowing against receivables because business is bad and the company cannot meet its expenses, banks will usually close the line. For small companies banks usually require a personal guarantee from the owners.

References

• Definition of Working Capital
• Working Capital Uses

Resources

• Discussion of Working Capital Financing