How to decide that your business needs Working Capital Loan?
Tuesday, January 10, 2017, 6:00 AM | Leave Comment
Working capital is an important part of every business entity. This capital helps companies run business operations.
Where seed capital is essential to establish a business, working capital is essential for running the business smoothly. There is a lot of conversation surrounding the importance of working capital.
However, let us first understand what working capital is.
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Working Capital – explained
Technically, working capital is defined as the difference between the absolute values of current assets over current liabilities:
Working Capital = Current Assets – Current Liabilities
In simpler terms, working capital depicts the sufficiency of current assets to meet the current liabilities of a business. So, if you have to pay your vendors or if you have an outstanding expense, working capital helps meet these expenses.
A typical cycle of working capital looks like this:
Stock held by businesses is sold on credit Those purchasing using credit are called debtors. Debtors pay cash to settle their bills. This cash is then utilized by the business to pay the creditors and purchase more raw materials to create inventory. This is how the cycle goes on.
What if the stock is not sold in any operating cycle? Or debtors delay payments? What happens when creditors demand payments and the business is out of cash reserves? Or a sudden surge in sales requires more raw materials?
In these and other situations, businesses need working capital loans. In fact, working capital loans are so important for industries that these short term loans in India represent more than 30% of the industrial GDP.
Here is RBI data showing the same.
Assessing working capital requirements for a business might be challenging.
While theoretically you might be able to assess your working capital requirements, practically, you have to look for certain signs which helps you determine that your business requires a working capital loan.
Do you know which signs depict the requirement of a short-term working capital loan?
If your answer is ‘No’, you don’t have to fret.
Here are a few questions which you think about to decide whether you require a working capital loan:
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Question # 1 – Are the operating expenses of your business being met?
Irrespective of the sales cycle your business might be experiencing, operating expenses are the basic business costs that must be met.
Your laborers need to paid, your factory and office power bills need to be paid, accruing rent of business premises needs to be paid and so on. Sufficient working capital keeps your business ticking by meeting such expenses, even if your business is experience a lull.
If your business is not able to meet its basic operating expenses, it is time for you to consider borrowing an unsecured business loan, which is one form of working capital loan.
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Question # 2 – Is your business production immune to demand cycles?
There are lean periods of sale and then there are phases in business when sales are high. Is your business prepared to deal with surges in production?
During lean periods, while the production continues, the stock turnover is low. Such low turnover limits cash inflow but cash outflow remains the same. As such, liabilities keep piling up and finance is needed to meet expenses.
During periods when demand is high, extra production is undertaken to meet the high demand and to maximize profit. This extra production needs cash to be pumped into the business, which is possible – by having sufficient working capital.
If you think that your business can handle both ends of the demand spectrum, you are in the clear. But, if you are challenged to deal with lulls and highs in demand, then working capital loans might be your solution.
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Question # 3 – Is business expansion on your mind?
Expanding the business requires investment. While the capital base of the business needs to be increased, the amount of working capital also needs to be increased.
Business expansions are characterized by increase in the scale of production. This increase requires finance and such finance can be met by procuring a working capital loan.
So, when you think of business expansion, think of availing a working capital loan.
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Question # 4–Do you want to create reserves for contingencies?
Profits generated by the business are usually channeled back into the business for meeting – operating expenses, unless these funds are reserved for future contingencies.
Contingencies, on the other hand, never come announced and when they befall a business, they tend to drain its cash reserves.
Reserves created for such contingencies are a result of prudent decision-making. Such reserves can be created only if the business has sufficient funds for meeting its operating expenses.
If you want to create profit reserves, you need to allocate sufficient funds for such business expenses. Such funds can be sourced through a working capital loan which is meant for financing the business’s operating expenses.
So, if creating cash reserves is on your mind, try and avail a working capital loan.
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Question # 5–Do you want to diversify your business?
Business diversification is a very popular choice for many businesses looking to expand their scope of activities. It ensures enhanced profitability and fortifies the brand name.
However, business diversification requires finance. Finance is required for setting up new production lines, engaging labor with the required skill set, setting aside promotion costs for the product, etc.
How do you arrange for this finance? While fixed assets can be financed through long term loans, other expenses require a working capital loan.
So, if business diversification is the next step in your business expansion program, you need to consider working capital loan options which are available in the market.
Different businesses have different strategies and yet the deciding factors for availing a working capital loan are often common among all types of businesses.
If you are also looking for answers to any one of the above mentioned questions, the answer lies in a working capital loan. So, avail the loan and build your business.
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