What is Working Capital Financing?

(Last Updated On: February 25, 2022)

For businesses that are struggling to pay their bills, a receivable factoring company can offer an option. The process of converting accounts receivable and outstanding invoices into cash allows these companies enough time so they don’t have any further debt weighing down on them while still earning revenue from sales in order for the business’s future success.

Invoice factoring is a popular option for businesses with unpaid invoices and aged receivables. The process allows these companies to extend credit, rather than simply relying on cash flow from operations or seeking external funding sources like investors who will want their money quickly so they can start making payments again (and this has been seen many times before).

What Is Working Capital?

Working capital is the amount of cash your business has available to pay its short-term liabilities. It’s calculated by taking your current assets and subtracting your current liabilities.

Your current assets include things like the cash in your bank accounts, the inventory you have on hand, and the money you’re owed for products or services you’ve already delivered.

Your current liabilities are what you owe others in the short term, like what’s owed to suppliers, employees, and other creditors.

How Does Working Capital Affect Cash Flow

In order to better understand how working capital management can affect the all-important free cash flow a business needs to survive, let’s consider an example.

Imagine that you run a small lemonade stand business. Your main costs include the ingredients to make lemonade, the cost to rent a small space in your local city, and an employee to man the register.

Each day, your lemonade stand generates sales of lemonade, suppliers must receive their payments, and your landlord needs payment every month. If your customers pay in the future for their lemonade purchase today, cash will have to come from somewhere to pay suppliers and employees.  If they don’t get paid eventually, the business will have to close. 

Especially in a growing company, it can be difficult to continue to fund accounts receivable. This is where invoice factoring comes in. 

What Is Invoice Factoring?

Invoice factoring means selling the money you’re owed to a company. In exchange for your invoices, you get an injection of immediate cash flow. Unlike a business loan or line of credit from a traditional bank where collateral and a good credit score are required, invoice factoring companies provide business financing by using the invoices to secure the loan. 

A benefit of invoice factoring is that the financing is non-recourse. This means that the small business owner doesn’t have to sign a personal guarantee. So even if the financing company isn’t paid, your business won’t have to repay the debt. 

Invoice factoring is commonly used by manufacturing companies to pay for supplies and wages while they are still making products. In factoring, a company sells its accounts receivable to a factoring service for a discounted price. The lender will advance 80% of the amount of invoices minus the discount fee (also referred to as a factoring fee), which is usually 3%. When the factor collects the invoice payments, they return the reserve to the company.