What is working capital? – The capital used by businesses to fund day to day operations.
In this article we look at short and long term sources of finance in relation to working capital. See our article on working capital to find out more about what working capital itself is.
Short term business finance and working capital solutions
Having a bank overdraft as a source of finance means someone is able to spend more than what is actually in their bank account. The overdraft will be limited. A bank overdraft is also a type of loan as the money is technically borrowed.
Invoice discounting is a form of asset based finance which enables a business to release cash tied up in an invoice and unlike factoring enables a client to retain control of the administration of its debtors.
Similar to invoice discounting, factoring is a way for businesses to fund cash flow by selling their invoices to a third party at a discount. Factoring facility arrangements tend to be restrictive and entering into a whole-turnover factoring facility can lead to aggressive chasing of outstanding invoices from clients, and a loss of control of a company’s credit function.
Why not read more about how to compare invoice discounting with factoring?
Income received in advance
Income received in advance is seen as a liability because it is money that does not correlate to that specific accounting or business year but rather for one that is still to come. The income account will then be credited to the income received in advance account and the income received in advance will be debited to the income account such as rent.
Advances received from customers
A liability account used to record an amount received from a customer before a service has been provided or before goods have been shipped.
Instalment credit is a form of finance to pay for goods or services over a period through the payment of principal and interest in regular payments.
A commercial paper is an unsecured promissory note. Commercial paper is a money-market security issued by large corporations to get money to meet short term debt obligations e.g.payroll, and is only backed by an issuing bank or corporation’s promise to pay the face amount on the maturity date specified on the note. Since it is not backed by collateral, only firms with excellent credit ratings will be able to sell their commercial paper at a reasonable price.
An exporter requires an importer to prepay for goods shipped. The importer naturally wants to reduce risk by asking the exporter to document that the goods have been shipped. The importer’s bank assists by providing a letter of credit to the exporter (or the exporter’s bank) providing for payment upon presentation of certain documents, such as a bill of lading. The exporter’s bank may make a loan to the exporter on the basis of the export contract.
Letter of credit
A letter of credit is a document that a financial institution issues to a seller of goods or services which says that the issuer will pay the seller for goods/services the seller delivers to a third-party buyer. The issuer then seeks reimbursement from the buyer or from the buyer’s bank. The document is essentially a guarantee to the seller that it will be paid by the issuer of the letter of credit regardless of whether the buyer ultimately fails to pay. In this way, the risk that the buyer will fail to pay is transferred from the seller to the letter of credit’s issuer.
Long term sources of working capital financing
Equity capital refers to the portion of a company’s equity that has been obtained (or will be obtained) by trading stock to a shareholder for cash or an equivalent item of capital value. Equity comprises the nominal values of all equity issued (that is, the sum of their “par values”). Share capital can simply be defined as the sum of capital (cash or other assets) the company has received from investors for its shares.
A loan is a type of debt which it entails the redistribution of financial /assets over time, between the lender and the borrower. In a loan, the borrower initially receives or borrows an amount of money from the lender, and is obligated to pay back or repay an equal amount of money to the lender at a later time. Typically, the money is paid back in regular instalments, or partial repayments; in an annuity, each instalment is the same amount. Acting as a provider of loans is one of the principal tasks for financial institutions like banks. A secured loan is a loan in which the borrower pledges some asset (e.g. a car or property) as collateral. Unsecured loans are monetary loans that are not secured against the borrower’s assets.
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- What is invoice finance
- What is factoring?
- What is spot factoring?
- What is invoice trading?
- What is invoice discounting?
- What is selective invoice discounting?
- Factoring vs invoice discounting
- The advantages and disadvantages of debt factoring
- How to compare factoring companies
- Invoice finance vs overdrafts
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- What is working capital?
- What is peer-to-peer, crowdfunding and alternative finance?
- What is the Peer-to-Peer Finance Association?
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