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What is working capital finance?

We explain what working capital is and look at sources of working capital financing.

What is Working Capital?

A business’s working capital is equivalent to the amount of cash it can deploy very rapidly, as such even very profitable businesses can have working capital problems, in particular this can develop because of long dated payments from clients.

MarketInvoice’s unique offering

Unlike conventional working capital solutions, MarketInvoice doesn’t charge clients monthly fees, or require them to use MarketInvoice a certain number of times a year allowing firms maximum flexibility. We don’t ask for a personal guarantee or demand onerous charges. We can also offer a completely confidential service.

Working capital explained

Working capital is the financing in a small business that helps a company pay its trade creditors and cash flow – it is the finance that businesses need for their day-to-day trading operations.

All businesses require working capital, but sometimes they are unable to access the cash that they need because they have to wait for large invoices to be paid – sometimes for up to 90 days.

There was a time when your bank would gladly help you through short-term cashflow difficulties with a loan or overdraft extension, but it’s become much tougher to access to bank finance. Even if you are successful, it can take can weeks to sort out – and you’ll probably have to provide a personal guarantee.

Another alternative is factoring, or a loan.

Short Term Sources of Working Capital Financing

Factoring

Factoring is a traditional source of short term funding. Factoring facility arrangements tend to be restrictive and entering into a whole-turnover factoring facility can lead to aggressive chasing of outstanding invoices from clients, and a loss of control of a company’s credit function.

Instalment Credit

Instalment credit is a form of finance to pay for goods or services over a period through the payment of principal and interest in regular payments.

Invoice Discounting

Invoice Discounting is a form of asset based finance which enables a business to release cash tied up in an invoice and unlike factoring enables a client to retain control of the administration of its debtors.

Why not read more about how to compare invoice discounting with factoring?

Income received in advance

Income received in advance is seen as a liability because it is money that does not correlate to that specific accounting or business year but rather for one that is still to come. The income account will then be credited to the income received in advance account and the income received in advance will be debited to the income account such as rent.

Advances received from customers

A liability account used to record an amount received from a customer before a service has been provided or before goods have been shipped.

Bank Overdraft

A bank overdraft is when someone is able to spend more than what is actually in their bank account. The overdraft will be limited. A bank overdraft is also a type of loan as the money is technically borrowed.

Commercial Papers

A commercial paper is an unsecured promissory note. Commercial paper is a money-market security issued by large corporations to get money to meet short term debt obligations e.g.payroll, and is only backed by an issuing bank or corporation’s promise to pay the face amount on the maturity date specified on the note. Since it is not backed by collateral, only firms with excellent credit ratings will be able to sell their commercial paper at a reasonable price.

Trade finance

An exporter requires an importer to prepay for goods shipped. The importer naturally wants to reduce risk by asking the exporter to document that the goods have been shipped. The importer’s bank assists by providing a letter of credit to the exporter (or the exporter’s bank) providing for payment upon presentation of certain documents, such as a bill of lading. The exporter’s bank may make a loan to the exporter on the basis of the export contract.

Letter of Credit

A letter of credit is a document that a financial institution issues to a seller of goods or services which says that the issuer will pay the seller for goods/services the seller delivers to a third-party buyer. The issuer then seeks reimbursement from the buyer or from the buyer’s bank. The document is essentially a guarantee to the seller that it will be paid by the issuer of the letter of credit regardless of whether the buyer ultimately fails to pay. In this way, the risk that the buyer will fail to pay is transferred from the seller to the letter of credit’s issuer.

Long Term Sources of Working Capital Financing

Equity Capital

Equity capital refers to the portion of a company’s equity that has been obtained (or will be obtained) by trading stock to a shareholder for cash or an equivalent item of capital value. Equity comprises the nominal values of all equity issued (that is, the sum of their “par values”). Share capital can simply be defined as the sum of capital (cash or other assets) the company has received from investors for its shares.

Loans

A loan is a type of debt which it entails the redistribution of financial assets over time, between the lender and the borrower. In a loan, the borrower initially receives or borrows an amount of money from the lender, and is obligated to pay back or repay an equal amount of money to the lender at a later time. Typically, the money is paid back in regular instalments, or partial repayments; in an annuity, each instalment is the same amount. Acting as a provider of loans is one of the principal tasks for financial institutions like banks. A secured loan is a loan in which the borrower pledges some asset (e.g. a car or property) as collateral. Unsecured loans are monetary loans that are not secured against the borrower’s assets.

What is working capital finance?

Working capital finance is defined as the capital of a business that is used in its day-to-day trading operations, calculated as the current assets minus the current liabilities. For many companies, this is wholly comprised of trade debtors (that is, bills outstanding) and trade creditors (bills the company in question has yet to pay).

Sources of working capital finance

Factoring facilities are traditional sources of working capital. Factoring facility arrangements tend to be restrictive and entering into a whole-turnover factoring facility can lead to aggressive chasing of outstanding invoices from clients, and a loss of control of a company’s credit function. Since factoring is an unregulated activity in the UK, factors have the power to turn off a credit line when they choose, starving many companies of the working capital needed to capitalise on growth opportunities.

Different providers for SMEs in the market

Despite the large numbers of providers of working capital finance, there is limited competition on pricing and structure of factoring facilities, primarily because all their funding comes from the same capital providers (the commercial finance divisions of the major high street banks). There is some competition on service between the independents, but once a company has signed up for 18 months, there are significant switching costs, and the factor effectively holds a monopoly over the business.

How MarketInvoice can help SMEs with Working Capital Finance

Marketinvoice is very different to the main short term source of working capital finance, factoring. Our three main advantages are flexibility, cost and scope.

  • In terms of flexibility, using Marketinvoice you sell the invoices that you want, when you want
  • Unlike traditional invoice discounting, there is no obligation to discount your entire debtor ledger
  • No lengthy lock-in periods

Marketinvoice puts you back in control of your cash flow as we provide a solution to late payments. Good credit management is absolutely necessary for a small growing business however late payments are fact of life even for the best-run businesses. We see ourselves as providing those well-run businesses with working capital and cashflow solutions, an area which hasn’t been satisfactorily filled by existing players in the market.