If you are running a big business you know that a running a company requires a lot of cash. Often your clients pay you after you deliver the products and often even 60 to 90 days after that. In such a scenario, it is easy to run out of operating cash even if your business may be profitable in theory.
Let us take a simple example. If you have $10,000 as operating capital and you receive an order from Client A. The order will requires you to use all of the $10,000 available to you. If your client will pay you $15,000 for the order, on paper you will be making a $5000. However, if your client pays you 90 days after receiving the order (very typical in many industries); you won’t have any cash in the interim. Now if another client, Client B, comes along with a similar order, what will you? You need another $10,000 to fulfill this order, without which you cannot meet the clients purchase order.
Most clients will not pay you $10,000 upfront for you to give them the product, so you need to raise your own operating capital. However, your money is locked in the receivable from the first client (Client A). Will you have to let Client B go one of your competitors?
Although you will make a profit with the order from client A, your business is out of working capital and you are in a position where you may have to leave the order from Client B. This is a problem which all big business face and it only increases as the business grows. Capital gets tied up in receivables and fixed assets like machinery, real estate.
As your business grows, the need for working capital grows; you will have to take decisions keeping in mind the available operating capital. For example, instead of purchasing equipment, you can consider leasing it; instead of buying real estate, you can rent the factory or office space.
Another way is raise operating cost using the assets you have. Working capital finance is an option which lets you take a loan against your invoices, receivables and other assets. If your business is in need of liquidity then taking working capital finance from banks can provide the capital infusion you need to fulfill new orders. Banks will take in to consideration the purchase orders you are trying to fulfill, your receivables and the value of the inventory you have and provide you a loan. This can be as high as 75% to 85% of the value of these assets.
The company in the above example can take the invoice from the order given by Client A and raise operating capital from a bank. Then use this operating capital and fulfill the order for Client B. Capital finance is used by many bug businesses and as well many small businesses as well. In some case you may be able to give the receivables to the bank and let them collect it on your behalf and pay you the difference.