Optimising Business Finances: Understanding Working Capital and Caveat Loans

Working capital is a crucial indicator of a business’s financial health and operational efficiency. It is the difference between a business’s current assets and liabilities, reflecting its ability to meet its short-term obligations and invest in its growth. Current assets include cash, accounts receivable, and inventory, while current liabilities include accounts payable, taxes, wages, and interest. 

A positive working capital means that the business has more current assets than current liabilities, which implies that it has enough liquidity to cover its expenses and invest in its future. A negative working capital means the business has more current liabilities than current assets, which implies that it may face cash flow problems or have difficulty paying its debts. Therefore, working capital management is crucial for a business to optimise its cash flow and profitability.

Managing Capital

Working capital management is planning and controlling a business’s current assets and liabilities to optimise its liquidity and profitability. It involves decisions such as how much inventory to hold, how much credit to extend to customers, how much cash to keep on hand, and how to finance short-term needs. Working capital management requires a balance between minimising risks and maximising returns. For example, holding too much inventory can increase storage costs and obsolescence risks, while having too little inventory can result in stockouts and lost sales. Similarly, extending too much credit to customers can increase sales but also increase bad debts and collection costs, while extending too little credit can reduce sales and customer loyalty.

The working capital cycle of a business is the amount of time it takes to turn the net current assets and liabilities into cash. A shorter working capital cycle means the enterprise can generate and use cash faster. A longer working capital cycle means that the business has to invest more money in its operations and may need to borrow more to fund its activities.

For example, a retail business may have a high working capital due to its high inventory turnover and low accounts payable. This situation means it can quickly sell its goods and generate cash while delaying supplier payments. On the other hand, a manufacturing business may have a low working capital due to its high accounts payable and low inventory turnover. This scenario means that it has to pay its suppliers before it can sell its finished products and receive cash.

Finding the balance can mean the difference between business success and failure. Good business owners must therefore ensure that their working capital is always positive to avoid complications that can burden the health of their business.

What Triggers Negative Working Capital

A good business owner must always be prepared for any eventuality, because like the weather, fortunes in business can turn at any time. Therefore it is always good business sense to learn how to spot the triggers of negative working capital in order to respond quickly.

The following illustrate situations that negatively affect the working capital of a business:

• A decline in sales due to seasonal factors, economic downturn, or increased competition. This sales decline can reduce customer cash inflow and increase inventory holding costs.
• A delay in collecting payments from customers due to poor credit control or lenient credit terms. This collection delay can increase the accounts receivable balance and reduce the cash availability.
• A rise in production costs due to inflation, scarcity of raw materials, or technological obsolescence. This situation can increase the investment in inventory and reduce the profit margin.
• A change in the production cycle due to technological innovation or product diversification. This change can alter the time gap between raw material purchase and finished goods sale and affect the cash conversion cycle.h
• A need for expansion or modernisation due to growth prospects or competitive pressure. This situation can increase the fixed capital requirement and reduce the working capital availability.

How To Avoid Negative Working Capital

A negative working capital cycle can have adverse effects on a business’s performance. It can reduce the business’s liquidity, profitability, solvency, and creditworthiness. It can also increase the business’s risk of insolvency, default, and bankruptcy. Therefore, a company should try to overcome the problems resulting from a negative working capital cycle by implementing some of the following strategies:

1. Track the working capital ratio and ensure it is within an optimal range.
2. Automate the financing processes of the business and reduce manual errors and delays.
3. Improve the stock/inventory management and avoid overstocking or understocking.
4. Find out ways to increase the sales revenue and accelerate the collection of accounts receivable.
5. Eliminate undesired/unessential expenses and optimise the use of resources.
6. Reduce bad debt and perform credit checks on new customers.
7. Utilise trade credit insurance and secure customer payment in case of default.
8. Cut unnecessary expenses and negotiate better terms with suppliers and creditors.
9. Find additional bank finance and access short-term loans or lines of credit.

The Caveat Solution

A caveat loan is one type of short-term loan that can help improve a negative working capital cycle. A caveat loan is a specialised financing that uses property as collateral. The lender places a caveat on the property’s title deed, which signifies their financial interest and prevents any other dealings with the property until the loan is repaid. A caveat loan offers several benefits for businesses with a negative working capital cycle:

• It is fast-settling, meaning that it can provide immediate cash flow relief for urgent needs.
• It does not require credit checks or proof of income, meaning businesses with poor or low credit history can access it.
• It is flexible and can be tailored to suit each business’s specific needs and circumstances.
• It is short-term, meaning it can be repaid quickly once the business improves its cash flow.

However, caveat loans also have some drawbacks that businesses should be aware of:

• They are risky, meaning that if the business fails to repay the loan, the lender can repossess and sell the property to recover their money.
• They are expensive, meaning they charge higher interest rates and fees than other types of loans.
• They are limited, meaning that they depend on the availability and value of property as collateral.

Therefore, businesses should carefully weigh the pros and cons of caveat loans before applying for them. They should also seek professional advice from financial experts or lawyers to understand their legal obligations and implications.

Caveat loans offer benefits and risks that can either help a business or burden it further. One must always weigh the pros and cons of caveat loans before embarking on this financing option. While caveat loans can be a potent tool for managing cash flow and seizing opportunities amidst rising interest rates and inflation, they also come with substantial responsibilities and risks that require careful consideration.

At Tiger Finance, we always guide you every step of the way with loan experts well-versed in the current situation in the world of financing. You can avail of a free consultation with our in-house financing expert without obligation to give you the most accurate picture of your loan situation today.

Contact Tiger Finance today so that we can help you begin your journey to secure the exact hassle-free loan product that you need.