Definition of Working Capital,
Working Capital Loan, And Working Capital Financing
The layperson’s understanding of
working capital, working capital loans, and working capital
financing is very fussy. In fact not a single non-financial
personal will be able to give anywhere close to the
definition of working capital.
Here’s a simple exercise for you.
Take a walk downtown with a microphone in hand. Ask the
first one hundred people you come across what "working
capital" is. Chances are the majority of them will be able
to give you some idea as to what working capital is. And,
I’m sure you probably (have an inkling about) know what
working capital is, Right?
But, if I were to ask you for the
definition of working capital, would you be able to tell me?
Okay. Enough of the exercise. I’m going to give you the
answer right here. Sadly, the average person almost always
gets it wrong.
Definition Of Working Capital
Working
Capital is technically defined as the difference between
Current Assets and Current Liabilities, i.e., "Current
Assets-Current Liabilities," and is also know as Net Working
Capital.
The working capital of a company
reflects its ability to meet its obligations as they come
due, and thereby avoid bankruptcy. Thus, the amount of
working capital may influence the character and scope of the
business. Working capital loans or financing are the funds
usually required to finance working capital short-falls.
It is believed in some finance
sector that the financing difficulties for small businesses
only increase when they seek funds for working capital (operating
expenses, purchasing inventory, receivables financing).
The reason? They say, unlike a loan for the acquisition of
fixed assets (land, buildings, machinery and equipment),
a loan for working capital does not provide the lender with
collateral thought to be as reliable for repayment purposes.
The Absolute Need For Working
Capital Loans
You see, new and small firms
typically find themselves in working capital crunches.
Without adequate working capital, they cannot build
inventory or purchase raw materials. Without adequate
inventory, the company cannot sell a sufficient number of
products to improve its financial condition. If a sufficient
level of financing is not available, the company may either
collapse or never realize its true potential.
Thus, the availability of credit is
a key determinant in the ability of small firms to expand
and grow. To lessen these problems for small and new
businesses and meet the demand, some private lenders have
instituted flexible working capital loan programs. In fact
some lenders offer collateral or "promise of repayment" to
back up working capital loans.
New Market Has Evolved
Such arrangements with this new
market involve third party entities (usually private
lenders) who promise repayment of a loan that is
obtained from lending institutions for working capital
purposes. By reducing the lender’s risk, this promise of
repayment increases the likelihood of the business obtaining
a working capital loan, and getting the loan at affordable
rates.
This is indeed a creative working
capital solution. Some professionals are beginning to call
it "the working capital sub prime market." Many small
business owners are rushing to take advantage by going
through this back door (new market) to meet their
working capital needs.
To learn more, you may participate
in our
Working Capital By Mail program,
or get our
free newsletter and our consultation services,
click here.
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