4 Types of Working Capital Finance: Which Do You Need?

Cash flow is one of the biggest issues firms face, especially when it comes to planning for future growth. Cash flow fears can take a significant toll on large businesses, as they can limit their ability to take on new staff, invest in new products or services and may mean a squeezing of margins as jobs need to be priced lower to attract more trade.

It’s for this reason that many companies make use of working capital finance. This is essentially a method of raising funds to grow a business with the intent of making the money back in the short to medium term.

There are many different ways in which a company can do this; here are four options to consider. Choosing which one to use depends on your business’ circumstances, so it’s important to pay attention to their advantages and disadvantages.

1. Credit cards

One of the simplest methods of securing short-term capital is to use a business credit card. The advantages of offering business credit cards to staff include the ability to keep a closer eye on company expenses, while the large limits usually offered on this type of credit means businesses can gain access to significant cash flow for immediate expenses that simply can’t wait.

On average, business credit cards have an APR of 15.32%. This isn’t going to be too bad if you anticipate being able to pay off the balance fairly quickly, but it will be a while before you recoup your investment then you could end up with a sizeable cost to your company. Credit cards are therefore best used for short-term financing.

2. Overdrafts

One of the more underutilized forms of financing is overdrafts. If a business bank account has a big enough overdraft, it can be used as a form of working capital finance. This is an extremely short-term solution, however. Using it means being completely unprepared for any unexpected costs that hit your business.

It also depends on how much your bank charges you for going into your overdraft, and how far in you can go. Typically, businesses will need to pay arrangement fees, maintenance fees/charges, as well as interest on any overdrawn amount at the end of each day. That said, this might be considered worthwhile if it grants you access to the capital you need to expand and you can refill your account quickly.

3. Invoice factoring

Sometimes also called invoice financing, this practice involves a third party purchasing a company’s invoices for a portion of their face value - typically 70% to 85% - and taking responsibility for collecting the payment from the client. When this is paid, the original company is given the remaining value of the invoice, minus a fee for the factoring process.

It can be a fantastic solution for businesses that are trying to grow and unlock working capital that’s tied up in future invoices. However, it might not be the most cost-effective option, and it can also be off-putting to clients as they will have to deal with the factoring firm when it comes to payments.

4. Asset refinancing

If a business has a valuable asset, such as a piece of machinery, it can often be refinanced to raise funds. This is similar to getting a second mortgage on a property; the business borrows a portion of the value of the asset, and the asset is used as security on the loan. The business doesn’t need to fully own the asset to take advantage of this, as long as it owns some of it.

This can be used to raise large amounts of capital very quickly. Lenders see this as a very safe option because it’s secured against an existing asset. However, businesses are limited by what they already own, so it may not be an option for those in industries that don’t require any valuable assets.