In the world of entrepreneurship and business financing, there are two factors that will let you know whether a commercial venture will be able to endure a period of crisis. Cash flow is one of those factors; it is defined as the revenue that a business is able to generate with specific frequencies. Working capital is the other factor, and it involves money that businesses are able to accumulate in reserve to be used during periods of low cash flow. We can also describe it as the means to keep operations going while taking care of outflows in a responsible manner.
When we talk about startup funding, this metric can make a significant difference in terms of financing or attracting potential investors.
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How do you calculate working capital?
The business accounting formula used to find this metric is rather simple. All you need to do is subtract what your company owes from what it owns. Invariably, this is a real-time metric, which means that the subtraction must include current liabilities and assets. Let’s look at an example for an established business:
- Business checking account $2,890
- Accounts receivable $12,598
- Inventory $60,000
- Company-owned shares $100,000
- Total current assets $175,488
- Accounts payable $9,607
- Accrued revenue taxation $3,894
- Rent $2,200
- Payroll $12,498
- Office supplies $890
- Total current liabilities $29,089
- Working capital $146,399
Any business that enjoys figures similar to the above can be said to be in solid financial shape.
How much capital will your startup need?
From an entrepreneurial point of view, you can never have too much capital or cash on hand when launching a startup. No one will ever complain about having access to a nice liquidity cushion, but let us not forget that many entrepreneurs have forged considerable success despite being forced to bootstrap their startups; companies such as Dell and Facebook come to mind in this regard. If you ask an accountant about startup capital, however, you will likely get the following answer:
Working capital should be approached as a business necessity. Estimating how much cash you need can be done by looking at how long it will take you to generate revenue after settling your core overhead expenses. The most practical way to go about this is to assume the standard net-30 payment term, which means that you have 30 days to pay for the inventory. Let’s say your startup delivers office supplies; in this case, your B2B customers also have 30 days to settle their invoices, and it takes you about 15 days to cycle through your inventory.
Based on the above, let’s say you spent $5,000 on inventory plus $10,000 on other expenses such as rent and payroll during a single month. You are looking at 45 days in which you need to have a liquidity cushion of $20,000 because another inventory run must be completed within that time frame.
What are five typical sources of business capital?
The sources below are the most commonly accessed by entrepreneurs who wish to turn their startup ideas into a reality:
This means reaching into your pocket despite knowing that you will not find much in there. The goal is to stretch the little cash you have by sticking to a strict budget that keeps expenses to the bare minimum.
You’ve likely heard of venture financiers and angel investors who are constantly looking to fund startups they feel could be the “next big thing.” This is how PayPal, Twitter, and quite a few other internet giants got off the ground.
Reaching out to loved ones and close friends is a very popular method of financing new business enterprises. According to researchers at the University of Ottawa, funds provided by Canadians to entrepreneurial relatives is three times higher than all venture capital investments.
Quite a few business financing options are provided through government programs that may include grants as well as loan guarantees. Government officials have important motivations to support the creation of small businesses; for example, when unemployment rates rise, one of the best methods to reduce it involves direct stimulation of the economy, and this can be certainly accomplished by increasing small business activity.
Once a startup takes hold and is ready to expand, outside financing may be required, and this is when financial institutions and business lenders can help business owners stay afloat. If you are ever in need of satisfying short-term business needs, a working capital loan with repayment terms in the range of three months and five years can definitely help to keep you afloat.
What is the best source of business capital?
While many business analysts will tell you that bootstrapping with close to zero cash is the best source of capital because it is readily available to anyone, the reality of entrepreneurship is that business loans often work out better, and this has a lot to do with business psychology. Let’s say the terms of your business loan call for payouts to be automatically made through credit and debit card transactions; this is a set-it-and-forget-it situation that appeals to many business owners.