What is working capital finance, and how does it work?

Maintaining healthy levels of working capital, the difference between a company’s current assets and liabilities, is vital for operating a business.

It ensures you have enough money to keep your business going and cover your costs.

Without it, your business could fail.

Working capital is also important for business expansion.

It helps entrepreneurs to seize growth opportunities such as taking on more employees, launching a new product, and doing business overseas.

To maintain sufficient working capital, funding could help.

This guide outlines some options and what you my wish to consider to give your application the best chance of success.

What is working capital?

Working capital is the money your business needs to maintain its day-to-day operations.

In simple terms, it’s the cash you have left once you have accounted for the money going out and the money coming into your business.

Working capital is vital for running a healthy business.

You need to be able to meet your financial obligations, such as paying employees and suppliers.

Maintaining adequate working capital will ensure the smooth running of your business.

Read our guide on cash flow and how to manage it.

Working capital finance overview

If your business is experiencing temporary cash flow shortages or you are looking to benefit from growth opportunities, working capital finance could be helpful.

Several types of working capital finance are available, and eligibility varies depending on many factors, including your sector, stage of business, and business model.

Your options include various types of loans – from capital investment to cash advances.

It’s a good idea to seek independent specialist advice when understanding what finance options best suit your business.

Working capital loans

Funding for day-to-day short or medium-term needs.

For secured loans, you’ll need collateral, and for an unsecured loan, your credit score will be important, as a personal guarantee is usually required.

Purchase order (PO) financing

PO financing is helpful for businesses that receive a customer order but don’t have the money to pay a supplier.

A lender provides a loan which covers the supplies.

Once the customer pays, the lender deducts their fees and gives the remaining amount to the business.

Invoice finance

This method, also known as factoring and discounting, involves receiving a loan with an unpaid invoice as security.

Merchant cash advance

An upfront payment is provided by a lender in exchange for a portion of a business’s future daily credit or debit card receipts.

Asset-based finance

A loan which uses assets on a business’s balance sheet as security.

Read our guide on how to get business finance without a proven track record.

How does working capital finance work?

Working capital loans can be secured or unsecured.

For secured finance, you must provide assets on your balance sheet as security for the loan.

This can be physical assets such as stock, equipment, debtors, machinery and property or intangible assets like intellectual property (IP).

For unsecured assets, the lender will be more interested in your business profile.

They will probably check your business’ turnover, history, and credit rating.

They might also investigate your credit score and request a personal guarantee.

Unsecured funding carries more risk for the lender so interest rates are usually higher, and the total amount you will be able to borrow will probably be less compared to secured finance.

Working capital finance can be a quick way to access finance, as a business often receives the money within 24 hours of an application.

Banks providing traditional bank loans can sometimes quickly approve an application, although they usually require more paperwork than methods such as invoice finance and merchant cash advances.

For invoice finance and PO financing, you pay a proportion of the value of the invoice as a fee.

Factors to consider when choosing working capital finance

There are various factors to consider when selecting working capital finance for your business.

It is recommended that you seek independent finance to select the method most suitable for your circumstances.

As with all funding decisions, you should consider your business’s financial situation and ability to repay debt.

It’s also advisable to evaluate the cost of working capital finance before applying.

Modern methods, such as invoice finance and merchant cash advances, can be quicker and easier to access than traditional bank loans, but the fees charged are often higher overall than the interest you need to pay on a bank loan.

The impact this could have on your business’s cash flow should be considered.

It’s a good idea to assess the effect of working capital finance on your business’ credit score and its long-term financial health.

Failure to repay the funding on time could negatively impact your credit score, reducing the chances of a future application for finance being approved.

Working capital finance could be beneficial for businesses with cash flow challenges or the desire to grow.

Not all solutions are suitable for all businesses, though, so it’s vital that founders carefully consider all their options before applying.

Read our full guide on working capital finance.

Reference to any organisation, business and event on this page does not constitute an endorsement or recommendation from the British Business Bank or the UK Government. Whilst we make reasonable efforts to keep the information on this page up to date, we do not guarantee or warrant (implied or otherwise) that it is current, accurate or complete. The information is intended for general information purposes only and does not take into account your personal situation, nor does it constitute legal, financial, tax or other professional advice. You should always consider whether the information is applicable to your particular circumstances and, where appropriate, seek professional or specialist advice or support.

Making business finance work for you

Our Making business finance work for you guide is designed to help you make an informed choice about accessing the right type of finance for you and your business.

Read the guide to making business finance work for you

Your previously read articles