Working Capital Finance
Working capital finance can help a business fund the gap between paying suppliers, staff and other operating costs and receiving cash from customers.
The right facility depends on where cash is being absorbed in the trading cycle and how that cash is expected to return to the business.
Profitable trading does not mean cash arrives at the same time as costs.
A business can be profitable and still experience pressure on cash. Stock may have to be purchased before it is sold, suppliers may require payment before customers settle their invoices, or a new contract may require expenditure before the first customer receipt arrives.
Growth can increase that pressure. More sales can mean more stock, larger debtor balances and higher payroll before the corresponding cash has been collected.
Working capital finance is therefore most useful where the requirement can be linked to an identifiable part of the trading cycle and there is a credible route for the borrowed money to come back.
What is causing the working-capital requirement?
The cause matters because different cash-flow problems call for different facilities.
Slow customer payments
Customers may pay in 30, 60 or 90 days while wages, suppliers and overheads have to be met much earlier.
Stock purchases
A wholesaler, manufacturer or retailer may need to buy inventory well before the resulting sale produces cash.
New contracts
A substantial order may require labour, materials, freight or supplier payments before the customer makes the first payment.
Seasonal trading
Businesses may build inventory or incur expenditure in advance of their strongest trading period.
Rapid growth
Revenue can grow faster than cash where increased sales create larger debtor, stock and payroll requirements.
Timing pressures
VAT, payroll, supplier payments or another predictable timing difference may create a short-term need for liquidity.
The facility should follow the source of the cash requirement.
Working capital finance is not one product. The structure should match the timing, assets and trading activity creating the requirement.
| Overdraft or revolving facility | May suit a fluctuating short-term requirement where borrowing rises and falls as cash moves through the business. |
|---|---|
| Invoice finance | Can release cash against qualifying unpaid invoices rather than waiting for customers to pay under normal credit terms. |
| Trade finance | Can support supplier payments, stock purchases or specific contracts where expenditure occurs before customer receipts. |
| Short-term business loan | May fit a defined requirement where the amount, purpose and repayment period are reasonably clear. |
| Asset-based lending | Larger businesses may be able to raise funding against several trading assets, such as receivables, inventory or other eligible balance-sheet assets. |
| Export working capital | Exporters may have access to facilities supported by UK Export Finance where qualifying trading activity creates additional funding requirements. |
A permanent requirement financed by repeatedly extending short-term borrowing may indicate that the facility no longer matches the underlying need.
What lenders look at in a working-capital case.
The lender needs to understand both the amount required and what the underlying trading information says about repayment.
Turnover
Historic and current sales, recent trends and whether forecasts are consistent with actual trading.
Margin
Gross and operating margins and whether the business generates enough value from increased sales to support the additional funding.
Debtors
Debtor ageing, overdue balances, disputes and reliance on a small number of customers.
Stock
Stock levels, ageing, turnover, obsolescence and whether inventory can be readily sold.
Creditors
Supplier terms, overdue balances and whether creditor pressure is increasing.
Cash flow
Monthly cash movements, seasonality and when the proposed facility is expected to reduce or repay.
Concentration
Dependence on one customer, supplier, contract or sector can materially alter the risk.
Existing debt
Current loans, overdrafts, invoice facilities, asset finance and other commitments already drawing on cash flow.
The lender wants to know when the money comes back.
A useful working-capital facility generally supports an identifiable cycle. A business purchases stock, incurs production or contract costs, makes a sale, invoices the customer and eventually collects the cash.
The length of that cycle affects the amount and duration of funding required. A business paid immediately by retail customers has a different working-capital profile from one supplying large corporate customers on extended credit terms.
This is also why growth can consume cash. Additional turnover often has to be financed before the additional gross profit is received in cash.
Questions worth answering
- When are suppliers paid?
- How long is stock held?
- When is the customer invoiced?
- How long does the customer take to pay?
- Is there material work in progress?
- What costs arise before invoicing?
- When does the cash requirement peak?
- What causes the facility to reduce?
Invoice finance can be useful where sales are strong but cash is sitting in unpaid invoices.
Businesses selling on credit terms can create a growing debtor book as turnover increases. Invoice finance can potentially convert part of qualifying receivables into cash before the customer settles the invoice.
The quality of the debtor book matters. Funders will normally consider customer concentration, ageing, disputes, credit notes and the nature of the underlying sale.
Current NatWest guidance describes invoice finance as a working-capital facility that can grow in line with eligible sales rather than operating in the same way as a conventional fixed business loan.
| Debtor ageing | How much of the ledger is current, overdue or materially aged? |
|---|---|
| Customer concentration | What proportion of the ledger depends on the largest customers? |
| Disputes | Are invoices subject to queries, retentions, set-off or contractual disputes? |
| Credit notes | Are deductions or credits material relative to invoiced sales? |
| Growth | Is the facility expected to increase naturally as eligible invoiced sales grow? |
Some businesses need finance before they can make the sale.
Stock-based and contract businesses can face the opposite problem to invoice-led businesses. The cash requirement arises before there is an invoice to finance.
Suppliers may require payment before goods are shipped, a business may need to build inventory ahead of a seasonal sales period, or a contract may require substantial labour and materials before the customer reaches a payment milestone.
Trade finance or an appropriate revolving facility may therefore fit better than funding based only on the debtor ledger.
NatWest currently describes trade loans as potentially supporting supplier payments, stock purchases and specific contracts. UK Export Finance also supports qualifying working-capital facilities for exporters through its guarantee schemes.
Further information on government-backed export support is available from UK Export Finance working-capital support .
Is the cash requirement temporary, recurring or structural?
Temporary gap
A defined short-term requirement may suit borrowing that is expected to reduce once a customer pays, stock sells or a contract reaches completion.
Recurring cycle
A business with predictable seasonal or trading-cycle requirements may need a revolving facility that can be drawn and repaid repeatedly.
Structural shortage
Where the business continually consumes more cash than it generates, short-term finance may simply delay rather than solve the underlying issue.
Working-capital finance is useful when the cash comes back through the trading cycle. It is much less useful when borrowing is being used to cover a business model that remains persistently cash-negative.
What we need to understand the cash requirement.
The first task is to establish what is absorbing cash, how much is required and what event is expected to release or repay the borrowing.
- Business activity and ownership
- Latest filed accounts
- Current management accounts
- Recent bank statements
- Debtor ageing
- Creditor ageing
- Stock position where relevant
- Current borrowing
- Monthly cash-flow forecast
- Amount required
- Purpose of the facility
- Expected repayment cycle
Understand the cash gap, test the repayment cycle, prepare the case and then select the facility.
Understand
Establish what is absorbing cash, how much is required and whether the need is temporary, recurring or structural.
Test
Review cash flow, margins, debtors, creditors, stock, concentration and existing debt.
Prepare
Present the trading cycle, historic performance, forecast and proposed repayment clearly.
Present
Approach lenders or funders whose product and credit appetite fit the underlying requirement.
The underlying requirement may point to a more specific form of finance.
Working capital can be funded in several ways. The appropriate route depends on whether the business is financing invoices, stock, contracts, equipment or a wider business investment.
Working capital finance questions
What is working capital finance?
Working capital finance is funding used to support a business’s short-term operating cash requirements, for example where cash is tied up in debtors, stock, contracts or seasonal trading.
What can working capital finance be used for?
Depending on the facility, it may support supplier payments, stock purchases, payroll, contract expenditure, seasonal requirements or the gap created by customers paying on credit terms.
What is the difference between invoice finance and a business loan?
Invoice finance is linked to eligible receivables and can change as the debtor ledger changes. A business loan normally provides an agreed amount that is repaid over a defined period under its own repayment schedule.
Can working capital finance help a growing business?
Potentially. Growth can increase the amount of cash tied up in stock, debtors and operating costs before the resulting customer receipts arrive.
Can working capital finance be used to buy stock?
Potentially. Trade finance, revolving facilities or other short-term business funding may be appropriate where inventory has to be purchased before it is sold.
When is working capital finance a poor fit?
It may be a poor fit where the business has no clear route to reducing or repaying the borrowing and the underlying trading model remains persistently cash-negative.
Discuss a working-capital requirement.
Tell us what is creating the cash requirement, how much is needed, the expected duration and what trading event is expected to reduce or repay it.
We can then consider whether the requirement is better suited to a loan, revolving facility, invoice finance, trade finance or another structure.
This page provides general information about business finance and does not constitute personal financial advice or a commitment to lend. EAS Finance is a trading name of Elite Admin Services Ltd (FRN 1044838), an appointed representative of White Rose Finance Group Ltd (FRN 630772), authorised and regulated by the Financial Conduct Authority. EAS Finance is a credit broker, not a lender. Lending terms and criteria depend on the individual business, facility and lender.