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Mastering How To Finance Working Capital: Unlocking Cash Flow Solutions | 7 Park Avenue Financial

Beyond Bank Loans: Diverse Ways to Finance Your Working Capital

Stay with us because we're addressing Canadian firms' most pressing questions about working capital and offering actionable insights.

The Challenges of Working Capital Financing

It is no secret to us here at 7 Park Avenue Financial that the Globe and Mail Oct 16/2023 article on SMEs in Canada bemoaned the fact that traditional commercial banking capital for small and medium-sized companies is shrinking with more and more businesses having a hard time securing loans' ( ' CANADA MUST IGNITE SMALL BUSINESS SECTOR ' )

It almost seems like a pipe dream. Having the cash flow and financing you need. And yes, don’t take it personally; even the big guys have that same challenge. Let’s examine how your company can assess and address methods to finance net working capital, accessing credit and financing in a manner that works.

Internal and External Perspectives

An excellent way to look at things is both externally and internally. From the internal perspective, it’s a question of knowing the amount of working capital you need and managing your day-to-day current assets on the balance sheet(primarily A/R and inventory) to optimize cash flow.

And from the external perspective, it’s about assessing solutions, but more importantly, solutions that work. It's those inflows and outflows that count. Probably the simple way to look at it is simply knowing your operating costs while at the same time collecting sales, i.e. your A/R, as efficiently as possible.

Common Mistakes in Financing Working Capital

When clients tell us they have made mistakes in their decision to finance working capital, we can almost guess what happened. They have mismatched funds, meaning that cash flow and working capital from operations may have been used to pay for fixed assets.

Traditional and Alternative Financing Options

It's easier said than done, but the 'normal' way to finance your business is short-term lines of credit, typically through your bank. However, credit and financing are difficult for small and medium-sized firms that can’t meet all the criteria a chartered bank requires.

Permanent Working Capital Injection

One solid option is injecting what we can call permanent working capital into the business. It’s a cash flow loan, payable in fixed monthly installments. This type of transaction is typically available through Canada's government-owned business bank, and you have to have solid proof of historical cash flow to show you can repay the term loan, which is typically unsecured!

Asset Purchase Considerations

We spoke of matching funds correctly. That’s important. So, if you are considering asset purchases, utilize lease financing, minimizing your cash outflow, of course, and allowing your company to structure a long term lease payment that matches the useful life of the asset you're purchasing.

Mixing Personal and Business Finances

Smaller and medium-sized businesses, mostly smaller, tend to mix the owner's personal finances with the business. That has positive and negative effects. The merchant cash advance loan has become popular as a working capital loan for many smaller businesses in the last few years, particularly retail. It allows you to monetize future sales, or 'cash flow ' today.

Tools and Calculations for Working Capital

When addressing the need to finance working capital, you should have a handle on the assessment tools. It's not as complicated as you might think. Calculate your day's outstanding sales and a similar calculation for inventory. Those two calculations will show the total time it takes for a dollar to flow through your company. You have to bridge that gap now with cash flow financing.

The Receivables and Inventory Ratio

General rules of thumb indicate that you need 2 dollars of receivables and inventory for one dollar of payables. That’s never been our favourite calculation because it simply reflects the build-up of those current assets. We're more concerned about turnover.

Assessing Working Capital Solutions in Canada

So, how do Canadian firms assess working capital solutions? In many cases, it all comes down to two issues: the size of your cash flow needs and your firm's overall credit quality. Large firms with solid financials can access bank credit to address negative working capital as required.

Financing Solutions for Smaller and Medium-sized Firms

Smaller and medium-sized firms have numerous options; some are short-term in nature, and many times they come with a higher cost, but, and it's a big but, it allows you to generate all the cash flow you need to grow your business.

Types of Financing Solutions

So, what are those solutions? They are receivable financing, inventory financing, purchase order financing, tax credit financing, and asset-based lending. Some, or a combination of these solutions, will allow you to finance your company's working capital adequately and access the credit you need to grow and profit.

Key Takeaways

Working capital is the difference between a company's working capital current assets (like cash, accounts receivable, and inventory) and its current liabilities (like accounts payable). It represents the liquidity available to a business for day-to-day operations.

Importance of Working Capital:

Adequate working capital ensures that a company can maintain its operations and meet its short-term debts when they come due. It directly indicates a company's operational efficiency and short-term financial health.

Methods of Financing Working Capital:

Short-term Financing: Includes bank overdrafts, short-term loans, and trade credits.

Long-term Financing: Equity, long-term loans, and retained earnings. They're primarily used for fixed assets but can also fund working capital.

Mismatch of Funds:

Avoid using short-term funds for long-term requirements and vice versa. For instance, using working capital to purchase fixed assets can strain day-to-day operations.

Alternative Financing Options:

Alternative solutions like receivable financing, inventory financing, and merchant cash advances can be explored for businesses that can't access traditional bank credit.

Conclusion: Seeking Expert Advice

Call 7 Park Avenue Financial, a trusted, credible and experienced Canadian business financing advisor, on how these solutions work, what they cost, and how they can, either singularly or grouped, solve the Canadian working capital and credit enigma.

FAQ FREQUENTLY ASKED QUESTIONS PEOPLE ALSO ASK MORE INFORMATION

What exactly is working capital?

Working capital is the difference between a company's current assets and current liabilities, signifying the liquidity available for daily operations.

Why is working capital crucial for my business?

It ensures your company can maintain its operations and meet its short-term financial obligations, reflecting its operational efficiency and financial health.

Can I rely only on traditional bank loans for working capital?

While bank loans are common, there are alternative solutions like receivable and inventory financing, especially if you can't meet bank criteria.

What's the risk of mismatching funds in working capital?

Using short-term funds for long-term needs (or vice-versa) can strain daily operations and lead to financial instability.

Are there tools to help me manage working capital better?

Yes, by calculating day's sales outstanding and inventory turnover, you can understand how money flows through your business and where to bridge gaps.

How does seasonality affect my business's working capital needs?

Seasonal businesses might require more working capital during peak periods to stock up on inventory and less during off-peak times. Planning ahead is essential.

Are there risks associated with alternative financing options?

Yes, while they offer flexibility, alternative financing can come at higher costs, and some might have less favorable terms than traditional loans.

How can I improve my business's working capital ratio?

Boost sales, speed up invoice payments, efficiently manage inventory, and renegotiate with suppliers for extended payment terms.

Does working capital affect my business valuation?

Yes, adequate working capital indicates good financial health and operational efficiency, which can positively impact your business's perceived value.

Can startups also benefit from working capital financing?

Absolutely! Startups, though they might have limited access to traditional bank loans, can explore alternative financing to support initial operations and growth.

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