Sunday, October 8, 2023

Methods of Financing Working Capital In Canada – Leveraging Current Assets

 

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Unlocking the Secrets of Successful Working Capital Financing

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Financing Working Capital: Unlocking the Power of Current Assets  | 7 Park Avenue Financial

 


 

Beyond Traditional Loans: Innovative Ways to Finance Your Working Capital

 

 

 
The Irony of Business Success  

 


Isn't it ironic that business can be actually quite good... Or even great..? This then becomes a problem only because in business survival and growth is all about  financing working capital... Turning those current assets of your firm into loans or monetization facilities for cash flow.

 



The Challenges of Business Liquidity

 


In a perfect world, Canadian business owners want to be able to meet their day to day operations, make any loan or lease payments and be able to plan to pay bills for upcoming expenses or growth. How could one statement like that induce so much stress?



A lot of that planning comes from the working capital current assets category of your financials, simply speaking your liquid assets such as cash on hand, receivables, and inventories if, in fact, your business has inventory. (Some services businesses just have A/R).

 

 

How does efficient working capital management affect a company's profitability? 

 

Efficient working capital management ensures that a company has a balanced mix of short-term assets and liabilities, allowing it to meet its obligations while investing in growth opportunities.

 

By reducing holding costs of inventory, optimizing collection periods, and managing short-term debts wisely, a company can improve its cash flow and ultimately enhance profitability. Poor management, conversely, can lead to missed opportunities, higher financial costs, and potential insolvency.

 

Working capital ratios, such as the current ratio and the quick ratio, are financial metrics used to assess a company's liquidity and short-term financial health.

 

The current ratio is calculated as current assets divided by current liabilities, while the quick ratio excludes inventories from current assets. These ratios provide insights into whether a company can cover its short-term obligations using its short-term assets. Consistently low ratios might indicate liquidity issues, whereas very high ratios might suggest inefficiencies in using available resources.

 

What external factors can influence a company's working capital requirements?

 

Several external factors can impact a company's working capital needs. These include:

 

  1. Economic Conditions: In a recession, customers might delay payments, increasing accounts receivable, while suppliers might demand quicker payments.
  2. Industry Trends: Seasonal industries might require more working capital during peak seasons.
  3. Interest Rates: High-interest rates can increase the cost of borrowing, affecting the decision to finance working capital through debt.
  4. Supplier Terms: If suppliers offer favourable terms, a company might require less immediate liquidity.
  5. Competitive Landscape: Intense competition might require businesses to hold more inventory or offer lenient credit terms, increasing working capital needs via  the company's ability to do so

 

Recognizing these factors helps businesses anticipate changes in working capital requirements and adjust their strategies accordingly to make short term investments in the business


 
Sources of Working Capital
 


Small and medium-sized businesses in Canada rely on either capital from their owner's personal resources, or their decision to take on loans and debt of some sort.

But what type of loans makes sense when it comes to liquidity? Perhaps a better rephrasing of that question would be 'What is good working capital debt?' In our personal credit lives, we think of good debt, i.e. a mortgage, and bad debt 'credit cards'!



Equity vs. Debt in Financing

 


Naturally considering new ownership or additional equity in your company or business (taking in a partner, etc.) is simply a dilution in the long run and somewhat downsizes the overall incentive for all owners to grow the firm.

And when it comes to debt the amount of 'debt' or loans your firm can take on is certainly often limited relative to your own current financials and the state of borrowing in Canada, which vacillates from great to not great as you may have noticed!

 

 Solutions for Working Capital Constraints

 


So, what's the solution? Is financing working capital the way to go? (As opposed to term loans and more debt). It’s not as complicated as you think. And it all comes back to our friends, those two guys known as 'current assets'!

A large part of working capital financing in your business can come from yourself. Real basics such as ensuring you aren’t paying your payables before you're collecting your receivables... if you're doing that you're simply creating a working capital shortage that you have self-imposed.

And let’s discuss your solutions for working capital constraints. We get a huge kick out of receiving newsletters from banks that focus on how to manage your cash surpluses when they are writing about working capital and cash flow. We haven’t had one client come in today with a cash surplus problem, but it's only noon...



Practical Solutions to Manage Working Capital

 


Canadian business owners and financial managers challenged with financing working capital have a solid handful of solutions. Naturally in a perfect world (you mean it's not?), you would prefer to not take on a term loan for permanent working capital. But back to that perfect world... that might mean you have an overdraft or bank line of credit. For many small and medium-sized businesses that simply is not attainable - or if it is, it’s not quite enough.

Real-world solutions for financing working capital and current assets without loans involve what we call the monetization or cash flowing of those current assets, Which typically is a working capital facility, non-bank in nature (yes they are available and exist!) that allows you to draw daily, as needed on your a/r and inventory in the form of a business line of credit. Larger facilities of this nature are termed 'asset-based lines of credit' - we call them ‘ABL’s... and they often are superior to bank facilities for a lot of different reasons.



Alternative Working Capital Solutions


Other working capital solutions, but nonetheless real, are financing your tax credits, purchase order finance, or securitization of your contracts or receivables.

 

 

Key Takeaways 

 


Working capital is the difference between a company's current assets (like cash, accounts receivable, and inventory) and current liabilities (like accounts payable).


Importance: It represents the funds available to a business for day-to-day operations. A positive working capital indicates a company can cover its short-term liabilities with its short-term assets.

Role of Current Assets:


Current assets are assets that are expected to be converted into cash or used up within one year, including cash, accounts receivable, and inventory.

They are crucial liquidity indicators. Ensuring these are efficiently managed means businesses can quickly access cash.

The Need for Financing Working Capital:

Businesses often require more liquid funds than on hand, especially during growth or seasonal fluctuations.

Financing provides the necessary funds to keep operations running smoothly without disruptions due to cash flow gaps.


Main Methods of Financing Working Capital:



The common ways include short-term loans, bank overdrafts, accounts receivable financing, and asset-based financing.

Understanding these methods gives insight into how businesses can maintain liquidity and seize growth opportunities without compromising operational efficiency.

Risks and Benefits of Financing:

While financing provides immediate liquidity, it also introduces debt which comes with repayment obligations.

Businesses must balance the benefits of immediate liquidity against the costs and obligations of taking on debt to ensure long-term financial health while accessing additional working capital and cash flows


  

Conclusion  

 


Call 7 Park Avenue Financial,  a trusted, credible and experienced Canadian business financing advisor on the right method of leveraging cash flow from your assets and business. Today would be a good timeframe!

 

 
FAQ: FREQUENTLY ASKED QUESTIONS  / PEOPLE ALSO ASK  / MORE INFORMATION 

 

 

What exactly is "working capital" in the context of a business?

Working capital refers to the difference between a company's balance sheet such as cash,  marketable securities, accounts receivable, and inventory) and subtracting current liabilities (such as accounts payable and accrued expenses).  Fixed assets are not a part of the calculation Net working capital represents the short-term available funds a business has to support its daily operations and meet its financial obligations. Business owners should understand how to calculate working capital formula and the working capital ratio.

Why is the financing of working capital important for businesses?

Financing working capital is crucial because businesses, especially growing ones, often require more liquid funds than they have readily available. Ensuring adequate working capital helps businesses maintain smooth operations, cover short-term debts, and invest in opportunities, without the constant worry of running out of cash and achieving a negative working capital position.



How are "current assets" different from other assets in a business?

Current assets are short-term assets expected to be converted into cash or used up within a year. This includes cash, accounts receivable, and inventory as part of the company's short term liquidity.In contrast, long-term assets, like property, plant, and equipment, are used over longer periods and aren't readily converted to cash.



What are some common ways businesses can finance their working capital to maintain a company's financial health?

Businesses can finance their gross working capital through various methods, such as bank overdrafts, short-term loans, trade credit, factoring or accounts receivable financing, and asset-based financing. The best method to generate cash often depends on the business's financial health, industry, and specific needs around the company operating cycle. Financial modeling and cash flow forecasts are important tools in effective working capital management and understanding of the cash flow statement.



Isn't taking on debt to finance working capital risky for a business?

While any form of debt or long term debt  comes with inherent risks, when managed prudently, debt can be a beneficial tool for a business. Financing working capital allows businesses to seize growth opportunities, manage cash flow gaps, and handle seasonal variations in revenues. The key is to ensure that the cost of the debt is outweighed by the benefits it brings, and that the business has a clear strategy for repayment.



 

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