When it comes to working and growth capital, business owners get frustrated with banks and banks get frustrated with business owners.
Banks get frustrated with owners who expect to get a loan or line of credit, even though they cannot prove the financial health of their company. Owners get frustrated with banks who will not take a chance on their ideas and hard work eventually paying off.
Owners can increase the odds of getting money if they learn to speak the bank’s language. You have to do things their way – their money, their rules. A part of doing things their way is knowing what they want to hear. They want you to talk knowledgeably about the difference between your working and growth capital, and how they relate to the loan request.
An understanding of working and growth capital will help you more effectively manage your short and long term finances, as well as significantly increase your chances of getting a loan when you want one.
Working capital
Working capital is the money you need to operate your business on a daily basis, the fixed expenses. Money for: payroll, materials, inventory, overhead, supplies, insurances, taxes, etc. It should also cover the cost of carrying the accounts receivables.
It is the money that comes in from customers and goes out to pay creditors. Banks want your total current assets to be higher than your total current liabilities. This will give you positive working capital and cash flow.
If you want a line of credit for working capital, you have to be able to show it can be covered by cash flow (liquidity). Cash flow which is usually tied to a company’s operating cycle.
Growth capital
Growth capital is money you do not need for your day to day operations. It is not used for fixed expenses. It is what is “leftover” from working capital and builds up over time. As the business gets more profitable, the growth capital can increase faster, because the working capital expenses are mostly consistent.
You save until there is enough to fund growth by having good faith money to apply for an expansion loan or spending it outright. Expansion through: new product lines, equipment, machines, an increased workforce, a new building, added locations, buying another business, merging, etc.
Keep working and growth capital separate
Most small businesses’ financials are a mess. Owners do not keep their working and growth capital separate. The two pots of money should not be used interchangeably. Typically owners use working capital for growth expenses. It does not work in the long term and usually creates serious problems for the average company. They use the money for growth that they need for daily operations and run out of cash for day to day expenses. Then they stop making a profit because the growing debt is too big to service, or they are making a profit, but the hole created by the under-financed growth is too deep to get out of.
All this could be avoided if owners understood the difference between working capital and growth capital.
In addition, you and your banker will get along just fine. Contrary to what you might think banks do want to lend owners money. But, they want to lend to someone who can pay them back, which is fair. You would not expend large amounts of credit to a customer who you know cannot pay their bill; only an impractical, naïve, soon to be bankrupt business owner does that.
At Cogent Analytics, we never stop looking for ways to improve your business and neither should you. So, check out some of our other posts for helpful business information:
