What is Working Capital and how can esellers benefit from it?

Working capital is one of the single most important pillars to your eSeller business. Your working capital means the cash that you have available to spend at more or less instant notice. It could be in cash form, or assets that are quick to liquidate like accounts receivable or inventory items.

Your working capital is closely linked with your cashflow, because your cashflow shows how quickly and regularly revenue flows into your business, which turns in to working capital. The chances are good that if you have a positive cashflow, you’ll also have a good working capital balance.

Why does working capital matter to my business?

It’s impossible to say this too many times: working capital is critical to your business. Without working capital, you might not be able to keep your business going, even if you have a high sales volume month on month. Working capital means that you have the money to pay for your regular day to day expenses, which don’t have any respect for your sales volume.

Expenses like salaries of employees, payments to suppliers and other essential bills can only be met if the business has enough working capital. Failing to meet either of these expenses can have serious repercussions for the business and can damage its performance.

Many small businesses like online retailers find that a lot of their capital is tied up in non-liquid assets. These put a big stopper in the middle of your cashflow, and can make it hard to find the funds for vital regular business expenses.

What can I do with working capital?

You can spend your working capital on just about any business expense, if you want to. But some business expenditure is better funded from other sources.

Working capital is ideal for dealing with short-term needs and items with short turnovers. If you have a small online retail business, you should use your working capital for:

• Buying your inventory
• Paying regular overheads like utilities bills
• Cash-heavy, infrequent needs like paying your taxes
• Dealing with sudden emergencies like fixing a broken window or paying a temporary courier

There’s a little debate about whether salaries for your employees should come out of working capital. On the one hand, payroll is part of your background running costs like utilities bills. On the other hand, it’s one of your biggest regular expenses, so you should budget for it out of your long-term capital or equity. It’s up to you how you choose to think about it; just be consistent and always use the same funding source for employee salaries.

The business expenses that you shouldn’t cover with working capital are generally any long-term investments or large purchases that you’ll be using for a long time. Essentially, you shouldn’t use your working capital to pay for anything that’s going to tie it up for a long time. That includes:

• Buying or renting office premises
• Renting warehouse space
• Buying or leasing expensive business equipment

For these purposes, you should look for other funding sources like a long-term business loan, an equipment leasing plan, or personal financing from savings, friends, or family.

How does working capital help me?

Having working capital keeps your business ticking over. You can enjoy a number of benefits from having a reliable, steady source of working capital:

• Good working capital means that you can pay your suppliers upfront instead of negotiating a credit arrangement, which usually brings you better terms and lower fees.
• If you have good working capital, you can ride out periods of low sales and stagnant demand without worrying about it bringing your business down. Good working capital smoothes out the inevitable dips and troughs in your revenue so that you can weather the bad times.
• Working capital allows you to increase your inventory ready for high sales seasons, like adding more stock just before the holiday sales period.
• Having access to enough working capital gives you the flexibility to respond quickly to a good business opportunity. You can act immediately to buy a large amount of discounted stock, expand your product lines as soon as you see a new trend, and cope with increased business by adding more staff.
• Working capital means that you can cope with a sudden emergency, like a higher than usual tax return, without worrying about how to fund it.

What happens if I don’t have enough working capital?

A lack of working capital can be serious for your business. If your working capital is too low, your business might not be able to continue.

Fortunately, there are a few ways to boost your working capital:

• Take out a business loan. However, you’ll add regular loan payments to your existing overheads, and you’ll have the burden of added debt.
• Use personal funding by getting a second mortgage, cashing in on a savings account, or using your personal credit card. It’s generally not a good idea to use personal funds for business needs – you could end up losing your home, your personal credit rating, or your financial safety net.
• Sell business assets. You won’t have any loan to repay, but it could affect your ability to run your business successfully in the future.
• Bring in a new investor. Although this is a quick way to boost your working capital, it also means giving up some control over your company, as well as diluting your profit share.
• Use a working capital advance. This is a way of accessing money from accounts receivable. If you have a payment that is on the way, but hasn’t yet arrived, you can get a working capital advance like Payoneer Capital Advance. This allows you to access up to 140% of the incoming payment ahead of time, and you’ll just settle that advance when the payment arrives. Capital Advance can offer up to $750,000 in instant funds with gradual collection from marketplace receivables, without needing to fill up unnecessary paperwork and only one attractive fixed fee.

Tips to Manage Working Capital Effectively

As discussed earlier, working capital is crucial to keep the business running and there are a few tips that can help you manage it effectively.

Manage Procurement and Inventory

You would spend most of the working capital on purchasing the inventory which means inventory must be comprehensively managed. Your inventory should neither have excessive nor insufficient stocks. It must be stocked according to the demands of the customers. Businesses should find the optimum level of stock for each product which can be done by analyzing the sales pattern of previous months. 

Prices of some products come down in some seasons and then go back up. It is the best time to purchase these products which will spare the working capital in the coming months. You can use accounting software to provide an alarm when the cheapest season kicks in for each product.

Pay Vendors on Time

Enforcing discipline when it comes to payables is the key to managing working capital effectively. Businesses that clear vendor’s payments on time develop healthy working relationships which can be leveraged to get better deals, prices and payment plans. Furthermore, payment to vendors takes a major portion of working capital and if it is cleared on time the financial picture gets very clear. You know exactly how much capital you have that can be invested or used for other expenses. 

In contrast, the business that drags its vendors would always find itself in pickles. You would end up investing more capital than what you should and would need a loan to clear payments to vendors when the time comes. It will create a cycle of acquiring and repayment of loans which is a poor long-term strategy.

Improve Receivable Process

Working capital is the amount that you have available at hand. The amount that is pending towards some customers does not classify as working capital. Hence, there should be a process in place to improve the receivables. You should send invoices as soon as possible along with the deadline that works for both of you. Do not count the amount in working capital until it is received in your account.

You can also set up a system to send routine reminders to customers to clear the invoices. Furthermore, integrate the business with a payment system that is widely used such as Payoneer. It not just works around the world but also allows customers to pay from other means such as bank accounts and credit cards. With such a platform, customers will always have a convenient means to transfer payment which will improve the receivables.

 Click here to learn more about how Payoneer Capital Advance solution can give you instant access to the working capital you need to help grow your eCommerce business.

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FAQs

What are some examples of working capital?

Cash and its equivalents such as funds in saving and checking accounts, treasury bills, stocks, securities and some types of bonds are a few examples of working capital.

What are the 4 main components of working capital?

The four components of working capital include cash, account payable, account receivable and inventory.

How much working capital does a small business need?

There is no fixed amount that works for all businesses because it depends on the projected sales and the nature of the business. However, experts believe that a ratio between 1.5 to 2 works for most businesses.  

How do you calculate working capital?

Working capital can be calculated by subtracting the liabilities from the asset at any particular point in time. If the company has $1,000,000 in assets and $500,000 in liability, it would have a working capital of $500,000.