Working capital financing is the strategy of securing financing to meet the typical and usual operating expenses associated with a given business enterprise. Financing of this type usually occurs when the receivables generated by the company are not sufficient to meet those expenses, often due to the amount of time it takes for customers to remit payment for outstanding invoices. With working capital financing, the company has money in hand to settle expenses in a timely manner, and repays the financing at a later date when the income is sufficient to settle the debt.
There are several ways to manage the task of working capital financing. One approach is to secure a working capital line of credit. With this approach, the company borrows whatever amount is needed to manage current operational expenses, assuming that amount is within the credit limit associated with the line of credit. One major benefit is that interest is only assessed on the outstanding balance. Should the company use the line of credit to settle expenses the first of the month, then pay off that balance a couple of weeks later, little or no interest charges are likely to result.
Another method of working capital financing is to obtain a short-term loan. This approach is often effective when income goes through seasonal cycles. A company can borrow enough to sustain the operation during off-season periods, then retire the loan once income levels increase during the peak seasons. Unlike a line of credit, interest charges begin to accrue at the time the loan is obtained. Assuming the rate of interest is offset by what the company would pay in terms of late fees to vendors, the loan may still be a viable means of financing the operation during slow periods.
Factoring is an increasingly popular approach to working capital financing. This method involves selling the most recent batch of generated invoices to a factoring partner. The partner in turn advances the company eighty to ninety percent of the face value of those invoices. Customers remit payments directly to the working capital factoring partner, who then applies those payments to the balance owed by the company. Once the amount of the advance is retired, additional funds are extended to the company when and as more payments are received on that particular batch of invoices. The factoring partner keeps a small percentage, usually three to five percent of the face value of the invoices, as the fee for providing the financing.
A similar approach to factoring is the cash advance based on credit card receipts. This form of working capital financing involves obtaining a short-term loan that is secured based on the amount of credit card payments the company receives each month. Lenders normally provide an advance that amounts to a percentage of those payments, with the understanding that the balance of the loan, plus interest, will be retired by a certain date. One benefit of this approach is that the lender does not require that a company’s customers remit payments directly to the lender, which means that the customers never have to know that any type of financing is taking place.