Paying for operating expenses is the No. 1 financial challenge among business owners, according to the Federal Reserve Banks’ Small Business Credit Survey. Specifically, 65% of entrepreneurs surveyed face this difficulty.
Needless to say, raising working capital is paramount for many firms. Here’s a breakdown of the 9 steps you can take to improve yours today.
1. Set Your Goals for Growth
Set measurable goals for growth, such as expanding to a new location, rolling out a new product or seeing a specific increase in sales. Depending on the growth you want to see in your current operating cycle, you’ll require a different amount of capital to cover expenses.
For example, if you want to see more sales, you’ll likely need to spend more on advertising. On the other hand, a goal of updating technology would require a different investment. Doing your research on the costs to meet your goals is key in calculating the working capital you need.
2. Spend Your Working Capital
Spend your working capital by wisely re-investing it into your business. While extra working capital can be a good thing, you still want to spend most of it because working capital fuels growth.
When you’re investing in advertising, marketing and sales or in expanding your product line, the money comes back to you. In turn, this creates more working capital, which can fuel your next stage of growth. Particularly if you’ve taken out a business loan, it’s important to generate cash flow from it as soon as you can by spending the loan on your business investments.
3. Allow Room for Change
Calculate the working capital to keep your business open or see it grow, then add additional funds to it. The extra working capital is to account for any unexpected costs that may come up (e.g., unanticipated legal fees, equipment failures or theft-related losses).
Take at least 5% of your working capital amount and add the dollar amount to your working capital for cushion. Whether you need to spend less cash, raise more or both, it’s important to have a little more than just what you need to get by.
4. Retain Profits
Retaining profits can be an advantage to businesses. Indeed, if your profit margin is high enough, you may be able to finance your growth by retaining profits in the business rather than increasing salaries or issuing dividends.
The money can also be used for the following investment activities:
- Business expansion
- New product launch
- Business partnerships or mergers
- Payment on outstanding loan debt
5. Increase Equity
You can avoid increasing your debt load by adding more equity to your business by growing revenue and decreasing expenses. A few practical ways you can do this include the following:
- Reduce employee costs
- Lower manufacturing costs
- Reduce costly office expenses
- Finetune sales strategy to increase profits
6. Take Out a Line of Credit
Consider a revolving line of credit, which can make up short-term deficits, cash flow and working capital. Similarly, having a company credit card in your arsenal can give you short-term cash when you need a safety net.
Once you know the amount of credit you’re eligible for, you can better determine your short-term budget available for spending on advertising and operations.
If you fall short of funding required to operate and advertise, your growth will slow and financial problems can snowball. That’s why it could be better to have a longer line of credit than you need, as opposed to not having enough.
Could you benefit from a line of credit?
7. Borrow Against Receivables
If you’re in the business-to-businesss space, consider using your accounts receivable to your advantage. Look into approaching a factoring or discounting service to leverage your unpaid invoices. This strategy can shorten your AR turnover rate and increase your working capital.
8. Finance Inventory
Working capital includes inventory. And if you’re a retailer or wholesaler, consider there are lenders who will make advances against your inventory to finance growth. Lenders may provide you with a loan or line of credit you can use to purchase products and stock, which serve as collateral for your financing.
9. Refinance Fixed Assets
If you need additional working capital and have fixed assets (e.g., property, machinery) that are paid off, consider tapping your equity. You can borrow against these assets and add the funds to short-term working capital needs.
Why You Need Working Capital
The idea behind having working capital in your business is to safeguard operations with a cushion of liquidity or spare cash. Here are the major benefits of having working capital on hand:
Keep Your Inventory Stocked
Being able to keep a full inventory status allows you to reach higher sales potentials. If you don’t have working capital available to spend, you don’t have to wait for your inventory to sell out before restocking.
Cover Unexpected Vendor Payments
If one of your vendors suddenly has a sale and it makes sense for you to stock up on extra inventory in advance, you save money in the long run by having cash on hand to make the purchase. Smart purchasing decisions are crucial in a business’s earliest stages, and having plenty of working capital can help you make the best financial choices.
Plan for Unpredictable Sales
Small businesses should always be prepared for erratic sales performance. Changes in demand or vendor supply can throw you for an unexpected turn. Having working capital keeps you operating and gives you the chance to recover.
Fund Your Growth Strategy
If your business is brand new and needs to show positive sales growth, having sufficient working capital is imperative for fueling that growth. You’ll need to cover advertising, pay your marketing and sales teams and make time for media coverage.
Meeting Your Working Capital Needs
Strategic growth in your business means understanding and raising the working capital required to meet your growth goals.
Whereas larger companies can fall back on larger credit lines, small businesses need to keep income and expenses balanced in a way that favors upward growth.