How to Determine Your Working Capital Needs

The availability of working capital is probably the most critical aspect of running a business smoothly and successfully. Also known as the current capital, working capital basically refers to the cash available with an organization for managing its daily operations and is calculated by simply deducting the current liabilities of a business from its current assets.

Assets that can be easily converted into cash within a year or a business cycle are termed as current assets and include cash, accounts receivables, inventories and short-term prepaid expenses. Similarly, current liabilities are the ones that a business needs to pay off within a year or one business cycle and includes accounts payable, accrued liabilities, accrued income taxes and dividends payable.

If current assets are greater than current liabilities, the business has a positive working capital situation or extra cash to meet unexpected expenses. Conversely, if the current liabilities are more than the current assets, the business is said to have negative working capital and needs to take working capital business loans.

Adequate cash availability also allows a business to take care of newer opportunities that require quick infusion of funds. However, not all businesses have access to adequate funds to carry out their operations smoothly and often need working capital loans.

Working Capital: Need and Importance

Every business needs to maintain some working capital to continue its operations smoothly. The amount of liquid funds available with a business is a measure of its ability to meet its short-term obligations. It is also a reflection of a company’s operational efficiency. Here are some reasons why working capital is essential:

Smooth Running of Business: Funds are needed for the smooth working of day-to-day operations and spending on the purchase of raw materials, overhead expenses and payment of wages and salaries. Working capital enables an uninterrupted flow of production or provision of services.

Goodwill: Sufficient cash with a business means it is capable of making prompt and timely payments, which in turn enhances its goodwill.

Easy Loans: Banks and financial institutions prefer to lend to organizations with adequate working capital.

Ability to Deal with Unexpected Expenses: Adequate availability of funds prepares a business to meet any unexpected expenses or situations.

Working capital is often used to judge the financial health of a business. A positive working capital situation indicates that a business is capable of paying off all its short-term debts, operating expenses and salaries with some extra amount remaining for reinvestment. In contrast, negative working capital is a cause for concern. It hints that the business may not be able to pay off its creditors.

Need for Working Capital Finance

Many businesses do not have sufficient cash in hand or liquid assets like money in the current account to meet their daily operational expenses. This is where working capital finance comes to their rescue. Small retailers or merchants typically require capital to fund seasonal inventory buildup. Also, businesses that do not have stable revenues through the year may still need to maintain a specific amount of inventory to fulfill any sudden increase in demand for their products. Such units often require a working capital loan to pay wages or meet other expenses during lean periods or when they are servicing an order, and the receivables would become due only after order fulfilment.

A working capital business loan is a short-term finance option that is generally repaid in the period when sales are high and the company has surplus cash. A major benefit of such credit is that its terms is short, which allows a business to maintain full control of its operations. Such loans need to be sanctioned quickly, without a lengthy approval process. Working capital funding can be secured or unsecured, depending on the financial product or lender.

Determining Your Working Capital Needs

The proper assessment of working capital needs is an important part of efficient financial planning. It allows a business to plan well and arrange the necessary funds on time to ensure smooth functioning of daily operations. The amount of current or working capital required by a business may vary. It is dependent on the operating cycle, or the amount needed to pay suppliers, the amount of inventory held and the time taken to collect cash from customers. Also, this may change with changes in demand for its products and services.

The working capital requirements of a business can be calculated by subtracting the accounts payable from the sum of the inventories and accounts receivables. Businesses need to fill the working capital gap by using internally generated profits or external borrowings or a combination of the two.

In case of new units or startups, working capital refers to the amount of money to be borrowed to keep operations going until the business starts generating adequate revenues to cover its operational expenses. Calculating the amount required to carry on business in the initial few months when there are no or very little revenues challenging and often leads to businesses borrowing too much or too little. A business should look towards raising working capital loans that have a prepayment option, or the option to repay the loan before the term is over.

Raising Working Capital Business Loans

Financial institutions use two ratios – the current ratio and the quick ratio – to measure the financial health or liquidity of a business. The current ratio is obtained by dividing the value of current assets by the value of current liabilities. A ratio above one means the current assets are more than liabilities, which is viewed positively. The quick ratio measures the proportion of short term liquidity (current assets minus inventory) to the current liabilities of a business. It gives a good idea of the company’s ability to meet short-term expenses quickly.

Working capital business loans are granted after assessing a company’s liquidity and working capital needs.

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Implications of GST for Services

The new Goods and Services Tax (GST) is a unified tax structure that was implemented by the Government of India on 1 July 2017. The new regime has ushered a significant change in taxation levels and rules associated with it. On an average, we see the tax slab increasing from 15% to 18% for most of the services. While this may translate to higher cost of services to the end consumer, GST also presents a whole lot of opportunities, pushing ease of business.

Services Sector in India: An Overview

India is a strong services-led economy with the sector generating a significant chunk of employment opportunities and contributing to the GDP. It contributed around 66.1% of India’s Gross Value Added (GVA) growth in 2015-16, is the biggest magnet for Foreign Direct Investment (FDI), and an important net foreign exchange earner. Some of the core areas of service are IT and ITES, banking and financial services, outsourcing, research and development, transportation, telecommunications, real estate and professional services.

Some of the positive impacts of GST on service providers are:

Clear distinction between goods and services: The old regime does not clearly distinguish between goods and services, leading to many instances of double taxation. For example, software is often treated as a good and as a service. The new regime clearly distinguishes goods from services, and also defines principal supply, composite supply, and mixed supply separately. For example, when an individual books a Rajdhani train ticket which includes meals, it involves a composite supply wherein the ticket and the meals cannot be sold separately. Since the transportation of the passenger is the principal supply, the rate of tax will only be charged on the ticket. Alternatively, for items that can be sold separately, but are sold together, like a hamper of snacks and aerated drinks, the rate of tax applicable on the higher product will be levied on the composite supply. There are also separate definitions for supply of software, works contracts, and leasing transactions to bring in more clarity and transparency on their taxation rules.

Streamlining of taxation for intra-state service providers: Due to the state level taxes being subsumed, it will become easier for service providers that operate within the state to know their tax obligations better. Such companies can move away from multiple tax calculations. For example, a CD with software incurs Excise, Service Tax, and VAT under the old regime; this is simplified to one unified rate under GST, making tax calculations and administration easier for intra-state service providers.

Input credit facility: VAT payment under the old regime was not eligible for setting off against output liabilities. The input credit facility is now made available to service providers as well, wherein tax paid on any inputs can be claimed and adjusted against tax paid on output. This will result in direct cost savings for service providers and may even offset the expected rise in end pricing. For example, an AC fitter who paid tax on the raw material for AC fittings (pipe, tape, solder etc.) will be able to claim that tax, and end up spending less on the cost of fitting the AC. This cost advantage can spill over to the customer as well.

Regularised return filing: The old service tax system required two half-yearly returns for services businesses. Under GST, this has been replaced by a number of returns provisions, depending on the type of taxpayer and the type of business:

Return Type of tax payer Timeline of filing return
GSTR 1 For outward supplies of sale (for registered taxable person) By 10th of the next month
GSTR 2 For inward supplies received by a taxpayer (for registered taxable person) By 15th of the next month
GSTR 3 Monthly return for registered taxable person (except for Compounding Taxpayer) By 20th of the next month
GSTR 4 Quarterly return for Compounding Taxpayer/Composition Supplier By 18th of the next month
GSTR 5 Periodic return by Non-Resident Foreign Taxpayer By 20th of the next month
GSTR 6 Return for Input Service Distributor (ISD) By 13th of the month succeeding the quarter
GSTR 7 Return for Tax Deducted at Source (TDS) By 10th of the next month
GSTR 8 Annual Return for e-commerce operator By 10th of the next month

While a shorter timeline for filing returns might seem overwhelming, regularisation in return filing will result in better streamlining of taxes. Since all these returns are required to be submitted online through a common portal provided by GSTN, the process is simplified and will help the government weed out regular defaulters. This in turn will result in a major boost in the contribution of the Service sector to the GDP.

Service providers, however, are concerned about the following aspects:

  • State-wise registration will be required: In the old regime, a service provider could operate with a single place of registration, since services were taxed only by the Central government. For example, if an IT services provider was present across states, they could carry out tax and delivery transactions from the main location. However, now a service provider that is offering services across states must register each place of business separately in each state. This is because the new GST regime entails taxation of services at “location of service recipient”, which will differ for different states. This means service providers will need to register afresh in new states and then carry out tax transactions separately in each state. For example, an IT company like TCS that has a widespread presence across states will need to decentralise service delivery.
  • Decentralised reporting will add to costs: Under GST, the “location of service recipient” is the key criterion for how a service will be taxed. Tax considerations will be related to the place the service is being delivered, and even a pan-India service provider with several “locations of service” will need to maintain state-wise records of input credit, audits, service consumption, etc. For example, earlier a service provider like TCS would enter into a single contract with the client, based on its main location, and then would discharge service tax based on the single-service tax registration model. GST will decentralise service delivery models, ensuring various TCS units adopt their own tax reporting and tax management. While this need for decentralised tax tracking and processing is an immediate cost to service providers, it presents a very real opportunity to streamline reporting and compliance measures for the future.

GST offers clear benefits to the services sector, and while some of these measures entail additional cost and effort in the short term, businesses can look forward to simpler operations with the new taxation laws.

All in all, services industries must gear up for better ways to manage business. Now is the time for them to equip themselves with the right people, processes and technologies, and emerge as service providers of the future.

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Oct 24, 2018

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Successfull business tips in 2017: way to grow

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Oct 24, 2018

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Considerations When Taking Short-Term Business Loans

Going the entrepreneurial route is a tough decision to take. Several people contemplate it, but only a few take that leap. Starting a business may be very challenging, but what is even tougher is running a business.

Most small businesses are faced with liquidity crunches. They are required to make payments for raw materials, overheads and staff before their receivables become due. Such businesses have not earned the confidence to ask their suppliers for a lengthy credit period. On the other hand, their customers are able to demand 30, 60 or 90 days before the invoice becomes due.

In such a scenario, small businesses find themselves at the mercy of large banks to raise short-term loans. Here are some challenges that SMEs face while applying for a short term business loan.

Estimating the Money Required: If a business underestimates the amount of money required, it would find itself unable to implement projects, execute orders, retain employees and/or realize its expansion plans. On the other hand, if a business secures a loan amount that is significantly higher than its requirements, it would be taking on an interest burden that is not justified by its bottom-line. Taking the right amount of loan can help the SME adequately address the working capital need without having a surplus or lack of funds.

Applying to Traditional Banks: Most entrepreneurs do not have the funds to invest in their businesses and keep it running for a couple of years. Borrowing from friends and family can also be tricky or simply not an option. In such scenarios, small businesses often turn to traditional financial institutions to raise short-term loans. However, these loans have a very time consuming and complex application process. There is plenty of paperwork involved. The business has to present financials in a predetermined format with supporting documents and detailed projections.

Loan Approval: The process of loan approval can be long and complicated. Banks may take several months to even reject a loan application. Mostly, loans are provided only against collateral, which the business owner may not have. Even then, lenders would conduct a thorough analysis of the financial standing of the small business. The lenders would verify all the information provided by the applicant and this takes a long time, during which the liquidity problem of the business continues to worsen. Therefore, such loans may not even be a viable option for short-term, working capital requirements.

Repayment of Loans: Most short-term business loans from traditional financial institutions have a fixed repayment schedule that is in no way linked to the cycle of receivables of the small business. Moreover, they do not allow prepayment of loans. Thus, these businesses would need to continue to bear the interest rate burden, even if it has the funds to repay the loan.

Against the backdrop of these inherent problems with securing short-term finance, technology has helped offer relief from severe liquidity crunches. FinTech companies like Capital Float rely on cutting-edge technology to offer innovative products that are aligned to the requirements and nature of small businesses. Here are some points to keep in mind while applying for a short term business loan.

Easy Application Process: The application can be sent online via a form that takes around 10 minutes to be filled. The borrower can digitally upload all the required documents.

Fast Loan Approval: The use of powerful algorithms allows Capital Float to approve or reject an application within minutes. Thus, a small business does not need to wait for several months to receive a response. Once an application has been approved, the short-term business loan is disbursed within 72 hours.

No Collateral, No Guarantor: Loans offered by Capital Float do not require small businesses to put up any collateral. Unlike traditional lenders, there is no requirement of a guarantor to validate the loan request.

Loans Designed to Suit Their Purpose: Probably the best news is that the finance products offered by Capital Float take into account the specific requirements and nature of small businesses. For instance, the Term Finance product has been designed specifically for manufacturers, traders and distributors, while the Online Seller Finance product is perfect for businesses that operate on online marketplaces. The Taxi Finance product is meant for companies that are part of the booming radio taxi business in India. Merchant Cash Advance is a loan against card receivables and Supply Chain Finance is finance against invoices from blue-chip companies.

Repayment of Loans: The repayment of loans offered by Capital Float either be in correlation to the receivables of the business or may be in the form of flexible weekly instalments. Moreover, there are no pre-closure charges, like those applied by banks and other lending institutions.

Small-term business loans are a highly effective way to finance business cash needs. However, one needs to calculate the amount carefully and then identify the right financing institute and the right product. A small business needs to opt for customized products that suit their individual requirements and offer flexible repayment options. The innovative short-term finance options available today allow small businesses to continue their daily operations without disruption and gives these enterprises confidence to grow without apprehension.

Oct 24, 2018