Put bluntly, without sufficient levels of working capital, a business will struggle to survive and extremely, will wither and die. Working capital reserves will help ensure that the business has sufficient cash reserves to hand that can be used for the settlement of immediate and imminent financial obligations that are outstanding, thereby ensuring that the business does not face bankruptcy proceedings by a creditor.
For some types of business, such as grokers and convenience stores, they are in the fortun position of requiring very small amounts of cash by virtue of the fact that they will receive instant revenue whenever they sell an item, and the expected turnaround time for the sale of their inventory is fairly minimal. However, other types of business (a whiskey distillery is a prime example) will have to wait for prolonged periods of time before their inventory reaches a sufficient level of security that will mean that it can be competitively sold to customers.
In the hiatus between the preparation of their stock and the actual sale, the company will inevitably incur various items of expenditure such as wages and salaries for its personnel, the cost of rent and tax, along with insurance premiums and security. At the risk of grossly oversimplifying a complex and advanced business topic, the more access to money that a company has to its name, the less likely that the company will encounter financial problems.
How would a business owner determine whether they require working capital loans? The equation of computing the need for working capital loans is very straightforward and is as follows:
Current assets-current liabilities = working capital.
Now that we have clearly identified the vital role that working capital plays in the health and economic durability and competitiveness of a company, what then are some of the benefits and drawbacks commonly associated with working capital loans? Again, these are as follows.
Benefits
- The business is kept more solvent, thereby insulating the company against the risk of bankruptcy or insolvency proceedings.
- By having sufficient high levels of working capital to hand, the business will be in a much stronger position to negotiate with banks and other commercial lenders in order to secure additional financial support.
- Working capital plays an integral role to the achievement and upkeep thereof, the goodwill (reputation and credibility) of the corporate personality in question.
- These types of loans are specialized loans designed to be provided to companies in the shortest period of time possible, thereby preventing precious time being wasted.
- Temporary and unexpected loss of income (such as where a high value customer suddenly stops trading for whatever reason) will not drag the company down.
Drawbacks
- The company must ensure that they strictly adher to the repayment schedule mandated by the lender, otherwise, they run the very real risk of suffering an adverse credit rating that will have long term ramifications as they are alienated from conventional financial support.
- These types of loans are primarily used and intended for short term items of expenditure only, thereby reducing their usefulness.