3 Ways to Improve Net Working Capital
(Read Time 1-2 minutes)
If you plan to explore a loan or small business line of credit, it makes sense to watch your company’s net working capital. This metric is a favorite of bankers when extending credit to small businesses.1 Keep in mind, net working capital is more important to creditors- equity investors are more interested in profitability ratios. Improving net working capital will go a long way in stabilizing your business finances.
What is Net Working Capital?
Net working capital reveals how well a business can be expected to meet short-term obligations. It is the difference between your company’s current assets and current liabilities on a balance sheet. Typically, the term “current assets”, implies be converted into cash in less than one year. This includes items such as marketable securities, inventory and accounts receivable.
For the liabilities, current liabilities are those expected to be paid within one year. These include short term debt, payroll taxes payable and accrued liabilities. Monitoring net working capital is crucial since running out of cash contributed to 29% of failed startups.2
Improving Net Working Capital
Having strong working capital can provide a competitive advantage for your business, especially if your competitors are struggling with negative working capital. It can also affect the rates and terms of such financing, affecting revolving credit lines.
Sometimes a lender will be more favorable when considering a loan even if net working capital isn’t positive as long as the trends are improving. So focus on the change in net working capital. There are a number of ways to increase your businesses’ net working capital. Here are three of our favorites:
An increasingly popular small business funding option is invoice factoring. Instead of waiting 45,60 or even 90 days for payment from credit customers, you immediately sell these receivables as soon as they’re invoiced to a third party factoring company. This provides immediate funding which can pay for business essentials such as payroll, inventory or debt repayment.
Invoice factoring kills two birds with one stone: It immediately improves cash flow and net working capital. Down the road, this can improves your chances of obtaining a traditional small business line of credit with better terms. But at that point, you may be working with a factoring company who has extended you a revolving facility of its own.
Keep in mind, if your client defaults on the payment, the factor may still come after you for the full amount. There is one way around this, non recourse factoring. This makes sense if your business has a couple outsized receivables which, if defaulted upon, would greatly harm your business.
There is a powerful trend in businesses choosing to be ‘asset light’. Selling a long-term asset (such as a building or heavy equipment) and turning around and leasing it from the new owner improves net working capital. Common in the real estate industry, the cheap cap rates available from historically low interest rates can be locked in for very long terms. It also protects your business from asset depreciation.
Also known as an asset refinance, the transaction is similar to accounts receivable factoring for current assets. But asset refinance unlocks the cash tied up in illiquid, longer-term assets such as equipment, vehicles, land and property. In addition to improved working capital, a new operating lease can lower the debt-to-equity ratio, lowering the business’ overall cost of capital going forward.3
Refinance Outstanding Loans
See if you can refinance an existing loan to a longer maturity. All else equal, this will increase net working capital by reducing the ‘current portion of long term debt ‘, a current liability.3 If selling a factory or building isn’t an option, considering refinancing the loan against it.
If your business has a traditional loan or small business line of credit (even with SBA loans) you may be able to refinance if the terms are deemed ‘unreasonable’.5 Examples of unreasonable terms may include seller financed deals, if the debt is on a revolving line or the line of credit lender is unwilling to renew.6