Working capital financing keeps money flowing through your business. Without sufficient cash flow, you can’t meet current liabilities or take on new opportunities. Cash is critical. 

When cash flow is tight, many companies seek external funding. But there are also ways to use the current assets on your balance sheet to raise capital.

In this guide, we’ll explore different approaches to working capital financing. We’ll also examine the solutions you can use to get the cash injection your business needs. 

What Is Working Capital Financing?

Working capital finance is funding designed to improve cash flow and liquidity. It’s primarily used to free up capital, so a business can meet short and medium-term commitments and continue to grow. 

You can use working capital financing to cover overheads during a cash flow gap or fuel growth if you need funding to capitalise on an opportunity. 

As a result of the COVID-19 pandemic and lockdown restrictions, Australian companies have seen working capital collectively decline by over $3.4b. 

With lockdowns easing, many organisations are leveraging working capital financing to bounce back and fund operations as they take on new projects and meet increased demand. 

3 Working Capital Management Strategies

There are three main strategies for working capital management. Each comes with its advantages and level of risk. The right strategy for you will depend on your unique circumstances and the maturity of your business. 

Conservative

A conservative strategy is a low-risk approach to managing working capital. It requires the business carries high levels of working capital. High levels of liquidity ensure that the company can continue to operate under cash flow pressures and cover unexpected costs. 

With a conservative approach, working capital financing typically comes from long-term debt and equity financing.

This strategy is low risk, but that also means less growth potential. Because a large amount of capital is tied up in assets, the business can be inflexible to change and unable to quickly pivot and take advantage of opportunities. 

Aggressive

An aggressive approach is considered a riskier way to manage working capital. But it can also maximise the efficiency of working capital and minimise the investment needed to grow the business. 

With an aggressive approach, working capital is maintained to meet liabilities without a buffer to absorb significant sales fluctuations or cash flow gaps. As a result, short-term increases in working capital demand is met with short-term financing. 

This type of working capital management provides flexibility, but it does require more frequent financing. 

Hedging

A hedging approach to working capital management is a balanced strategy where working capital requirements are offset with financing options of the same maturity. 

For example, an increase in seasonal demand is met with a short-term funding option. The funding is required for a short time to buy seasonal inventory and is repaid once the inventory is sold. 

The current growth stage of your business will influence which type of working capital management is right for your company. 

8 Working Capital Financing Options

The right working capital financing strategy for your small business could include a combination of the following funding solutions.

Trade Finance

Trade Finance is used to support around 80% of all trade transactions globally. This type of financing can include trade credit and third-party funding. 

Trade credit is when your supplier offers net payment terms. You can receive inventory before you need to pay. This can significantly impact cash flow as it enables you to generate revenue before settling the supplier’s invoice. 

A Trade Finance facility is an effective way to free up capital in the supply chain when your purchase from a domestic or international supplier.

With Trade Finance, the lender pays your supplier immediately, but you only have to pay for the inventory once you have received the goods and fulfilled customer orders.

When combined with an Invoice Finance facility, Trade Finance can fund cash flow gaps of up to 180 days. With increased purchasing power, you can also negotiate bulk buying and early payment discounts with your suppliers.

Invoice Finance

Invoice Finance helps businesses to leverage their unpaid invoices to get fast funding. If you sell to other businesses on net terms, you may be able to access up to 95% of the value of your unpaid invoice as a cash advance. 

When your customer pays the invoices, you receive the remaining balance, less fees. 

This type of funding can be a good option for growing businesses that need funding to meet customer demand and cover cash flow gaps caused by extended payment terms. As your business grows and you raise more invoices, your line of credit increases. 

Invoice Finance can be tailored to the needs of your business with the option of confidential funding or full-service facilities that include account management and collections.

Read our guide, Invoice Discounting vs Factoring?, to learn more about the different types of Invoice Finance. 

Equity Finance

Equity finance is a broad financing category that typically involves selling shares or part ownership of your business. While the financing doesn’t involve debt, you will have to share future profits and give up some control of your business. 

This type of financing can come from angel investors, venture capitalists, or friends and family members willing to invest in your company. 

Equity finance can improve cash flow as part of a conservative approach to working capital management. However, this type of funding is generally not suitable for short-term cash flow needs.

It can take a long time to find someone willing to invest in your business, and you’ll need to go through the legal process of selling part of your company before you receive funding. 

Merchant Cash Advance

If your business sells directly to consumers and processes lots of credit and debit card sales, a merchant cash advance can provide a fast injection of working capital.

A merchant cash advance enables you to use your future credit card sales revenue as collateral for funding. The finance company will provide a cash advance and automatically collect a percentage of your future card sales until the principal and interest are repaid. 

The amount you repay depends on your credit card revenue, so you only pay what you can afford each day. However, merchant cash advances are one of the most expensive types of working capital financing. 

Read our guide, The Pros and Cons of a Merchant Cash Advance, to learn more about this type of funding. 

Business Loan From a Bank

Business loans from a bank are one of the most well-known types of working capital funding. After being approved, you will receive a set amount that must be repaid over the loan term. 

Most business loans provided by a bank are secured by property and require the business to have an established trading history and strong credit rating.

As a result, interest rates are usually more affordable, but the application process is more stringent and can take several weeks or months.

Due to the extended application process and need for property collateral, business loans from a bank often do not provide the flexibility that many small businesses need to thrive. 

Business Credit Cards

Business credit cards can be a good option to cover small incidental expenditures. You can use your business credit card to pay for an expense and repay the cost later. 

But credit cards are not a sustainable way to support working capital long-term. The interest rates are generally higher than other types of working capital financing. If you don’t clear your credit card balance at the end of each month, interest and fees can quickly mount up. 

The approval process can sometimes be easier than a business loan from a bank, but you may still be required to provide some property collateral.

Choosing a Working Capital Financing Strategy

The right working capital strategy for you will depend on how quickly you need funding and your business circumstances. 

For many small businesses, a combination of financing options is the best way to meet your funding needs and achieve your business goals. 

Here at ScotPac, we help businesses like yours get the funding they need to keep growing and overcome cash flow gaps.

Call the number below or fill in our simple online application form, and we’ll help you get the funding your business needs to thrive.