Working capital financing: how fast funding answers urgent SMB needs

A smooth cash flow cycle can be the difference between a healthy, high-functioning business, and one that just barely scrapes by. Even if your products are great, your customers are happy, and you have strong supplier relationships, a few late payments or a sudden dip can put you behind. 

That’s where working capital financing comes in. This funding goes straight to your daily operations, to help cover immediate costs or respond to a sudden increase in demand. This makes it a highly targeted, tailored form of financing. 

There are several different types of working capital funding available, each with its own pros and cons. This article explores these different forms, and the key benefits of raising working capital financing for small businesses. 

What is working capital financing? 

Working capital financing is a form of borrowing used to fund your company’s day-to-day operations. Unlike longer-term financing, used for research and development and other ongoing investments, working capital financing delivers immediate liquidity when you need it most. 

This is in contrast to startup loans or venture capital fundraising. These are typically used to get a company off the ground—before you even have cash flow to worry about—or to take your business through a major step up.

Working capital financing should be used for a set (short) period of time, to respond to specific cash flow needs. Done well, this lets SMB owners get highly strategic with their cash flow, and preserves your savings and other funding sources for a rainy day. 

5 types of working capital financing

There are many kinds of working capital financing, and some may be more or less suitable for your business. Here are a few of the most common. 

• Working capital loans. Some banks and other lenders offer short-term loans to cover discreet, immediate needs. This can be an option if you already have a good relationship with your bank and have a good credit history.
  
  The downside is you’ll need to apply for each loan individually, and the application process can take time. It’s almost certainly a slower option than many of the others on this list, which means it’s not the best choice for regular financing.
  
  
• Bank overdraft. Many business bank accounts offer an overdraft—a line of credit to dip into when necessary. You’ll almost certainly need to apply specifically for this—unlike personal bank accounts, most business overdrafts are not pre-approved and will have a fixed end date.
  
  You’re also unlikely to get a large amount of credit this way. An overdraft is suitable on an occasional basis, where the amount required is really quite low.
  
  
• Factoring and invoice financing. Factoring lets you “sell” unpaid customer invoices to a third party, in exchange for the cash upfront. The factor is then responsible for collecting payment from the customer. Invoice financing also lets you borrow against unpaid receivables, but you’re responsible for the collections.
  
  

These options both bring money in ahead of schedule to use as working capital. And while some factoring arrangements remain slow and complicated, there are fast invoice financing options available. The biggest considerations are fees and interest, which can be high in some arrangements. So the shorter and more flexible, the better.

• Inventory financing. Another smart option for working capital funds, inventory financing lets you borrow against unpaid payables. This is incredibly pragmatic: you have specific working capital needs in the form of supplier invoices, and you can borrow to cover these exact costs.
  
  With faster access to cash, you may be eligible for early payment discounts from suppliers. In many cases, those discounts can be greater than the fees and interest you pay for the financing. Used strategically, it’s an incredibly smart cash management strategy.
  
  
• Open-ended credit. Also known as “revolving” credit, this lets you dip into funds as and when you need them. Crucially, you pay no fees or interest until you take on debt, but that debt facility remains available to you.
  
  A working capital line of credit is therefore among the most flexible, user-friendly sources of funds for SMBs. They also often have lower interest than regular loans, and lower fees than factoring because there’s less administration involved.
  
  The best part: the amount of credit available typically grows with each successful repayment. As you prove your business credit worthy, lenders are willing to give you more borrowing freedom. 

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There are plenty of other variations and alternative lending arrangements available. The best fit for you will likely depend on the terms you can find, and the kinds of assets you can bring as collateral. 

Key benefits of working capital financing

A few of the chief advantages of working capital financing—as opposed to long-term debt or equity funding—include:

Cover urgent shortfalls

The obvious use case for any kind of short-term financing is to cover immediate needs. This includes cases like an unexpected slow month, a sudden rush of demand, or emergency costs stemming from damage or an accident. You need a quick cash injection that fits outside your normal operating costs. 

But “urgent” doesn’t mean that these cases are unforeseen or unexpected. Your business might have the same seasonal surges every year, and you could use working capital financing as a regular tool to come through these in good shape. 

What’s important is that funding is used to respond to specific working capital requirements in a timely manner. 

Improve your cash conversion cycle

Outside of urgent costs, there’s the strategic side to healthy cash management. Some business models have inherently asymmetrical cash flow: money goes out faster than it comes in. That doesn’t mean you’re overspending, it’s just that customers take longer to pay you than your suppliers are willing to wait. 

Services agencies are a good example. Most clients pay agencies and consultancies up to three months after the work is done. But those agencies need to pay staff, freelancers, and suppliers long before that time.  

That’s why SEO agency Akolads uses invoice financing to speed up its cash conversion cycle, getting funds sooner for client invoices due in the future. 

The same applies for companies with inconsistent cash flow. You may receive large payments all at once, and then have long periods with nothing coming in. Working capital financing smooths these gaps and ensures you have cash on hand. 

Maintain flexibility

Longer-term loans tend to have more strings attached, and more rules around how and when you repay them. Working capital financing tends to be fast and flexible—you borrow for a specific need over a set (short) period of time. 

And depending on the type of financing you choose, you’ll also get more choice in what you use as collateral. You can avoid tying up precious assets, and instead either use outstanding invoices or no collateral at all. 

Avoid diluting your ownership

All of the examples above are “non-dilutive” financing. Even though you’ll pay some fees and/or interest, you hold onto your ownership stake in the business. This is in contrast to selling off a stake in the business, bringing in partners, or raising equity capital. 

While taking on debt can be nerve-wracking, it’s generally seen as “cheaper” in the long run than equity fundraising. Of course, equity fundraising also has a time and place, and can be a great option. But it’s an absolute last resort to cover short-term working capital needs.

Keep borrowing costs low

Long-term debt implies long-term interest payments. You’ll also have this liability sitting on your books for a year or more, which can be challenging psychologically as much as financially. 

Ideally, you’ll find a low-cost, flexible working capital financing option. Some charge as little as 0.05% per day, with no hidden costs or administrative fees. But even if you pay higher rates, the ability to repay quickly and get the burden off your books may be a huge advantage. 

Get strategic about working capital

Working capital optimization is a smart SMB’s secret weapon. Your ability to deploy cash at the right time in the right areas is a key differentiator. 

Part of this is speeding up your payment cycles and bringing in predictable revenue. But it’s also about finding the right funding sources to respond to key moments, and avoiding getting into long debt cycles. 

For real-life examples, read how these three SMBs use working capital loans to great effect. These are normal businesses with typical challenges, doing that little bit extra to master working capital. 

Or if you’re looking for working capital financing, find out if you’re eligible (and for how much). It takes seconds, and you could have the funds you need faster than you imagine.