Working Capital Finance

What is working capital?

Working capital is the difference between what a business owns in the short term and what it owes in the short term. In accounting language it is current assets minus current liabilities. In plain words, it is the cash, stock and money owed by customers, less the wages, supplier bills, tax and loan instalments that fall due within the next twelve months.

A business with positive working capital can meet its obligations as they arrive. Many healthy businesses sit close to the line for part of the year, which is where working capital finance earns its keep.

The working capital cycle

The working capital cycle is the number of days between paying for something and being paid for it. A wholesaler buys stock, holds it for 30 days, sells it on 45-day terms and receives payment at day 75. If the supplier wanted paying at day 30, the business funded 45 days of trading from its own cash. Multiplied by the value of goods moving through the business, the sum can be substantial. The cycle lengthens when stock sits for longer, customers pay later or suppliers tighten their terms. Working capital finance bridges the gap while the business works on shortening the cycle.

Types of working capital finance

• Working capital loans are term loans, usually unsecured and repaid over six months to three years, used to put a lump sum into the business for a known purpose such as a seasonal stock build.
• Revolving credit facilities set a limit that can be drawn, repaid and drawn again. Interest is charged only on the amount in use, which suits a business whose need rises and falls.
• Business overdrafts work in a similar way through the current account, although limits have become harder to obtain and can be withdrawn at short notice.
• Trade finance pays suppliers, often overseas, for goods that have been ordered, with the facility repaid when the goods are sold.
• Invoice finance advances cash against unpaid invoices, so the facility grows with sales rather than being fixed.

How it differs from cash flow finance and consolidation

The phrases overlap, but the emphasis is different. Cash flow finance is usually an unsecured loan assessed on trading income, taken to cover a shortfall or an unexpected cost. Working capital finance is broader and is tied to the trading cycle, which is why asset-backed products such as invoice finance sit within it.

Neither is the same as business debt consolidation, which replaces existing debts with one new facility. Working capital finance adds a facility to support trading, and a provider will assess it on top of what is already owed.

Who does working capital finance suit?

It suits a business that is profitable on paper but short of cash at certain points, for example a retailer stocking up before December or a contractor whose customers pay at 60 days while staff are paid weekly. Fast-growing businesses also qualify, since growth ties up cash in stock and debtors.

It is a poor fit where the shortfall is permanent. If the business loses money each month, a facility delays the reckoning and adds interest to it. The business cash flow problems page helps separate a timing issue from a structural one.

Eligibility

Providers generally look for a UK-registered business with at least six to twelve months of trading, a current account showing regular income, and no recent serious credit events. Limited companies, LLPs, partnerships and sole traders can all apply, although lending up to £25,000 to sole traders and small partnerships is regulated consumer credit and requires the provider to hold the relevant Financial Conduct Authority permission.

For unsecured working capital loans to limited companies, a personal guarantee from a director is standard. Invoice and trade finance rely on the underlying invoices or goods instead.

Documents usually requested

• Three to six months of business bank statements
• Latest filed accounts and recent management accounts
• A short cash-flow forecast showing when the facility will be drawn and repaid
• An aged debtor and creditor list for invoice or trade facilities
• Identification for directors or owners

What does it cost?

Pricing depends on the product. Term loans carry an interest rate and often an arrangement fee. Revolving facilities and overdrafts may add non-utilisation and renewal fees. Invoice finance charges a service fee on turnover plus a discount charge on funds advanced. Any introducer or broker fee must be disclosed before you commit.

Compare offers on total cost over the expected period of use, not on headline rate. Our guide on how to compare business finance offers sets out a method.

Benefits and drawbacks

How to size a working capital facility

Start with a weekly cash-flow forecast for the next six to twelve months. Note the lowest point the bank balance reaches and how long it stays below zero. That trough, plus a sensible buffer, is the facility the business needs.

Then match the shape of the need to the product. A one-off dip for a known reason points to a short term loan. A recurring monthly pattern points to a revolving facility. A gap that grows with sales points to invoice finance. Our article on how to improve business cash flow covers changes that can shrink the gap before any borrowing is arranged.

Alternatives to consider

• Negotiating longer terms with suppliers or deposits from customers.
• A secured business loan where property is available and a longer term is appropriate.
• Asset-based lending for larger businesses with stock and receivables to borrow against.
• A Time to Pay arrangement where the pressure is tax arrears, see our HMRC tax debt page.
• Free, impartial help from Business Debtline if the business cannot meet its commitments.

Frequently asked questions