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What is Working Capital?

By , 21 May 2020

What is Working Capital?

As they say, it takes money to make money. Working capital is the amount of money your business brings in minus the amount of money it costs your business to run. A business has many expenses: payroll, rent, utilities, and taxes!

Let’s take the coronavirus. For the past ten years you’ve had a bakery that supplies 40 local restaurants with all their buns for their burgers. Suddenly, all these restaurants always close or they go to half time. You still need to make buns for the remaining 10 restaurants that are open and that brings in 1/3 of what you normally make. However, your business is still paying the same amount of rent, property tax, electric, water, and trash. Let’s say that your break even was 20 restaurants. That means you’ll be short.

What choices do you have? You can close up your shop, but that means that you’ll be laying off workers and have to file bankruptcy. You can wait for a small business loan, but in the meantime, these restaurants will have to switch to another company for the next 5 weeks and they might not come back to you as a customer. You can pull from your child’s college fund, or you can seek out alternative funding to bridge the gap while you wait for a grant or a lower interest rate small business loan.

There is another alternative situation.

Let’s say this same bakery is trying to expand and received a contract to make flavored bread slices for a large corporate company’s cafeteria. It’s the opportunity of a lifetime! They are offering you an exclusive contract for $20,000 a month worth of bread. You do the calculations and it’ll cost you $6000 to make the bread. The problem is this corporate company pays on what they call a Net 90. That means that they’ll pay you every 90 days or 3 months. This means that you have to make 3 months worth of bread, pay for 3 months of rent, pay for 3 months worth of payroll AND continue to supply bread to other restaurants…and you won’t get paid until 3 months later. While the $60,000 is worth it, how will you finance the extra cost until you get paid?

These two stories are very real. And these two stories represent a great case of why a business might be short on working capital. The misnomer is that businesses need money because they aren’t doing very well. In these cases, the businesses need money to bridge a specific gap that traditional lending cannot help. Their liabilities are more than their assets…but these businesses don’t need a bailout. They need temporary relief.

Say this bakery needs extra kitchen equipment. They might look for

or equipment financing to solve their

. Perhaps they just need cash for payroll. They might seek a

.

There are all types of pros and cons, so as a small business do your research! At GetBackd, we pride ourselves on being honest and helping business owners find the right solution for their needs. Reach out to us if you have any questions.