There are broadly two sources of working capital – a fixed or permanent side which is usually financed by long term funding and a variable one. The likes of shares, term loans, retained earnings, etc. act as the permanent source of capital. Variable sources include finances from short-term financial lending sources like public deposits, trade credit, commercial bank loans, factoring, discounting bills of exchange and similar financial solutions.
Both the long as well as short term financial lending for working capital can be broadly demarcated into two sources, external and internal. Broadly, the external sources are financial aid from lenders in the form of business loans and other alternatives such as, shares, etc. Internal sources simply to solutions which come from the internal working of the systems like tax provisions, billing discounts, profit retaining etc.
To have a continuous check on how much working capital your business needs, you need to have a consistent source of funds at hand. Here are some of the most basic sources of working capital for individuals.
Commercial bank loans:
Typically a mortgage based system; these sources of working capital offer the option of repayment either as a single payment, or as that of instalments. Known as clean advances, these loans do not demand any security before disbursement of capital. Available typically to small-scale industries, a concessional interest rate is generally in effect. Though this is a cheaper source of raising capital, it has the downside of being time consuming.
Any business organisation authorised by the Companies Act 1956 can employ a simple method to generate fund for their variable working capital; they offer shares. While this is quite a convenient source of generating capital, it does carry a certain amount of risks during recessions and disasters.
Companies have different types of discounts and credit dealings with their suppliers. When a supplier provides the raw materials at credit, they are effectively providing a short-term finance for their clients.
While trade credits help as a working capital, it robs a client of any discount. Reputation as well as volume of demand greatly decides the availability of trade credit, and it is generally granted for a period between 3 to 6 months.
A method employed to manage book debts and receivables for companies, here the debts are assigned to a bank called ‘factor’, thereby acquiring the name. The bank releases funds in advance and charges a percentage of the value as commission.
Bank overdraft and cash credit
Overdraft is a facility can provide a sufficient short term solution to financial shortfall. In this mode of credit, financial institutions lend from current account or against securities, for a small period of time akin a week or so. Interest is calculated on just the amount of money that exceeds the current account cap. Lenders such as Bajaj Finserv offer a similar feature in the form of its Flexi Loan facility. Business owners can easily use a Flexi loan if they run out of cash to continue business operations.
Financial institutions also allow money to be borrowed in cash, though a cap called ‘cash credit limit’ is in place. Change in value of securities revises the limit, repayment being borrower’s convenience.
Advances from customers
A simple but effective way of raising money for short terms is simply making a request for advance payment from customers. This is an extremely convenient method of raising short term funds and its best bit is that the company does not have to pay any interest.
A simple method of fundraising, this does not involve any cost of its own. Like salaries becoming due when a month ends, but is effectively paid in the next month; the expense then can be temporarily used as working capital.
External financial assistance can provide the necessary financial assistance in case of financial shortcomings. Rather than the above discussed ideas, one can go for other more options available in market, like choosing asset refinancing, invoice financing, merchant cash advance funding on tax bills.
The sources of working capital being varied have their own uses and one ought to choose according to their necessities. While neither is any random way of raising money applicable for all working capital requisite, nor can their random usage be safe.