Working capital is a metric that represents the operating liquidity available to a business on any given day. In addition to a company’s fixed assets, for example equipment or owned facilities, operating capital is also factored into the equation. If a company’s current total assets are less than the company’s current liabilities, or financial obligations within the fiscal year, the company is said to have a working capital deficiency.
Small businesses that have working capital deficiencies often find it hard to get to the next stages of growth. As small businesses mature, many seek working capital finance in order to get to the next stages of business without putting a serious strain on their existing cash flow.
Short term and long term working capital finance arrangements can work in a number of different ways for a small business – it can help a business fulfill purchase orders, carry out contract obligations and expand facilities.
Knowing about the different types of working capital finance is crucial for small businesses that are headed towards a working capital deficit or are already in this type of situation. Read more about the types of working capital finance below to see if any of these arrangements are suited for your small business needs.
Accounts Receivable Financing
Accounts receivable financing, or A/R as it’s commonly called, is asset-financing that allows a company to use its receivables as collateral in a financing agreement.
With A/R financing, companies are able to free up capital that would otherwise be help up in accounts receivables. By transferring the default
Purchase Order Financing
Purchase order financing, also called P.O. financing, is a short-term finance arrangement (with no interest charged) in which a lender provides capital to businesses that need funds to fulfill single or multiple customer purchase orders, likely from national retailers or government agencies.
P.O. financing can be extremely helpful for a business that receives a large purchase order but doesn’t have the capital to fulfill the purchase order with existing cash flow. When considering a P.O. arrangement, the lender will look into the credit of the borrower’s customer (not the small business producing the goods). If the end customer has a good track record of paying bills on time and has the finances to cover the goods it has ordered, it’s likely that a financing arrangement will be made.
This type of financing can be a huge help to small businesses that receive occasional large purchase orders that need financial assistance without entering into a long-term loan solution.
Production Financing
Production financing is an option for manufacturers who need capital to expand facilities in order to produce goods.
Lenders in this space offer secured loans for new or used equipment in addition to loans for expanding facilities. These lenders also often offer sale leasebacks and financing for industrial projects where the debt is repaid from the cash flow generated by the new business.
Contract Financing
Contract financing can be a good solution for small businesses that have locked-in contracts with customers and need working capital. In this arrangement, lenders advance money on work contracts so that small businesses have funds for day-to-day operations before payments on the work contract kick in.
Typically, a small business will seek out contract financing when they enter into a contract larger than any previous engagements and need immediate capital in order to fulfill the contract while also managing other business obligations.
Unlike other forms of working capital financing, contract financing is specifically designed to aid small businesses that need an advance on their contracted work before a service is completed, but not necessarily before work on a product is complete.