Working capital represents the cash available to finance the short-term operational needs of an operating business. Often a business does not have adequate cash on hand or asset liquidity (cash flow) to cover daily operational expenses. This is when working capital financing becomes a critical part of the day-to-day need of a viable operating business. Working capital loans are generally used to finance short-term assets such as accounts receivable, inventory and other current assets in order for the business to be able to timely manage its normal operating expenses such as wages and salaries, accounts payable and other general operating expenses.
Many businesses do not have steady or readily available cash flows throughout the year due to the nature of their particular business or industry cash cycle (Cash to Inventory to Account Receivable back to Cash). Therefore they have the need to borrow against their current assets until those assets are again returned to cash – hopefully at a profit. The benefit of working capital financing is that it allows the business to manage their cash flow needs during this recurring business cash cycle.
Working capital loans are most often comprised of revolving lines of credit established for up to 12 months at a time. This type of financing may consist of simple unsecured revolving lines of credit, all the way up to intricately structured, secured credit facilities. These secured credit facilities may be governed by monthly borrowing base agreements with prescribed advance rates against current assets as well as other detailed loan agreement covenants which place specific restrictions, monitoring guidelines and prescribed safeguards on the usage of the credit line.
Another type of very formal/controlled working capital financing is “Factoring.” Some banks will engage in factoring operations. However, most often this type of financing will be managed by a factoring company with this specific specialty. Generally, under a factoring arrangement, accounts receivable are purchased by the factoring company at a prescribed discount and fee structure. The business receives immediate cash for their accounts receivable, while the factoring company manages the collection of the account receivable. This type of arrangement effectively eliminates short-term debt from the balance sheet of the business and can be a very effective, albeit higher cost, alternative to normal working capital borrowing.
General bank considerations in the establishment and type of working capital lines relate to: the general creditworthiness/capitalization and successful operation of the business; timeliness and collectability of the accounts receivable; marketability and condition of inventory; experience of management; and the seasonality of the business’s cash cycle and economic conditions as they pertain to the particular business.
FirstCapital Bank of Texas
is staffed with experienced commercial lenders fully engaged in this type of crucial business financing. If you need consultation, our team of lenders are ready to meet and discuss with you how working capital financing might be of benefit to your business.