A Smarter Approach to Working Capital (Whether You’re Big or Small)

a-smarter-approach-to-working-capital-whether-youre-big-or-small

How a big business owner thinks about working capital

Bigger businesses are inching closer and closer to zero working capital.

Why? Their size empowers them to negotiate better terms with their suppliers, not because they CAN’T pay, but rather because they WANT to use the funds for other opportunities.

Companies like Dell, GE (General Electric) and Campbell Soup are working towards zero working capital in order to improve their financial models. They use the extra capital to grow their sales at a higher rate than the cost of capital. So they’re generating more money with the money they either owe to suppliers, or have borrowed at a lower rate.

As a small business owner, you don’t necessarily have the same position of power. Trying to push for better supplier terms, while aggressively using the extra capital, can feel like walking on a tightrope. It just might not be worth the risk of falling.

How can you use the same “big business” financial models to lower your working capital, without risking defaulting on payments?

A step back: Why business owners intuitively believe in working capital

With extra cash or liquid capital, you can:

  • always pay your vendors on time
  • balance your cash flow, without constantly worry
  • pay your workers fairly and consistently
  • take on extra projects
  • buy additional goods or services to grow
  • account for seasonal fluctuations

While these benefits provide a nice security blanket, they also bring along costs. Beyond paying the interest cost on a working capital loan, they also create an opportunity cost, of passing up on revenue that you could generate by using the capital for extra projects or inventory.

A sometimes unnecessary luxury: the cost of excess capital

This cash flow fear causes many businesses to operate with more working capital on the books. As a result, they order less inventory, pursue projects less aggressively, or use small business financing to offset their liabilities.

The interest rates for this extra small business capital can be as high at 50+% APR for alternative loans and 15-25% for really good deals, according to Inc.com. In reality, much of this money sits in the business’s bank account, despite its high interest cost.

How smaller businesses can operate like bigger businesses

Obviously, you can’t bear the same level of risk as Dell or GE, because late payments could hurt your relationships with suppliers, or even cause them to cut you off. But, you can now use the same concept of less working capital through an accessible credit line, and avoid paying interest on money that you may never use.

Like a working capital loan, a simple working capital line entitles you X dollars of capital to pay your expenses, which you can repay at a later date. So you can order more inventory to boost your revenue, or take on that project you were waiting to fund.

With a working capital line, you can now:

  • Maintain smooth cash flow, even throughout tougher periods
  • Demonstrate your creditworthiness to suppliers or investors
  • Ensure on-time payments to suppliers and employees
  • Only pay interest on the money that you actually borrow