Definition of Working Capital
When you subtract the current liabilities from the existing assets, you get the working capital. Working capital helps take care of the daily expenses of a business.
- Current Assets: They include liquid cash and other assets that you wish to convert to money before the end of a financial year such as inventories or accounts receivable.
- Current Liabilities: These refer to any debts that a business owns and which it must clear before twelve months elapse, like short term loans.
Working capital is essential because it will help you know the amount of money you have to run your business once you have accounted for all the current liabilities.
Balancing Cash Flow
Many businesses fail because they lack consistent cash flow. The biggest challenge that entrepreneurs face is how to balance cash and ensure their business is healthy and flowing smoothly. When a new business needs working capital, the owner will turn to personal liquidity, investors, friends and family, bank loans or factoring.
Once a business owner exhausts all personal assets and does not want to give control of his business to an investor, they have two options left, a bank or factoring company. The business owner will first visit a bank to apply for a loan. However, banks have many regulations that you must adhere to, making it difficult for entrepreneurs to secure loans. Factoring comes in handy at this point, and the business will have the necessary capital to keep the business running.
What is Factoring?
It refers to the selling of invoices to acquire working capital which in turn provides the business with the liquidity necessary for growth. Factoring offers a financial package that includes, working capital, protection from credit risk, bookkeeping of account receivables and collection services. A factoring company Australia will purchase account receivables from a business at a discount hence allowing the business to access capital instead of waiting for a month or two for a customer to pay for an invoice. A factor will buy invoices from the company, pay the business a portion of the account receivables immediately and clear the balance after collecting from the customers.
There are two major types of factoring:
- Recourse: The factor is at liberty to demand that the client pays them if customers fail to pay for account receivables.
- Nonrecourse: Here, the factor cannot demand payment even if customers will not pay.
The factor is highly dependent on the clients’ customers; therefore, it will take time to determine the creditworthiness of a new customer.
Factoring is not a loan, and that is what most business owners like about it. The owners are not borrowing money; hence there is no collateral involved. They get immediate cash and do not need any paperwork, unlike bank loans, which are also slow. Factoring, therefore, acts as an extensive line of money for the business.