Business optimism is running high. The National Federation of Independent Businesses (NFIB) Small Business Optimism Index has hit record highs for two years running, with small-business owners adding employees and stocking up on inventory in anticipation of growing sales. And that puts the spotlight on working capital—the cash flow that funds a business's day-to-day operations such as payroll, rent, office suppliers and inventory.
Many business owners may be tempted to borrow money to boost their working capital and take advantage of opportunities for growth. It's no coincidence that small business lending applications and approvals are up significantly as well, according to Biz2Credit's Small Business Lending Index.
“In a stronger economy, businesses need more money," says Rohit Arora, CEO of Biz2Credit.
But with interest rates rising and the future uncertain, business owners should think carefully before taking on a working capital loan.
If your company needs to finance inventory that will be converted to product and sold over the course of a year, then look for a line of credit that gives you a full year before your have to pay it down.
–Christine Rico, founder, CEO on Speed Dial
So when does it make sense to look at payment solutions to supplement cash flow and boost working capital? The key, says Arora, is to be very clear about what you need and how you will use the money. “Is it for payroll, marketing, expansion? They should be very clear about that," he says.
The best use of a working capital loan or line of credit is for expenditures that will pay off in the short term. “Anything with a short turnaround time that will give you a return in a year or several months' time is fair game," says Arora. That can range from a new hire to upgraded equipment to inventory.
One common example is a seasonal business that must invest ahead of time in inventory and other inputs to prepare for the busy season—such as a toy retailer stocking up for the holidays or a farm that must invest in seeds and equipment months before the crops are harvested.
Seasonal businesses regularly use short-term loans or lines of credit to get them through the predictable slow periods when they need to invest in future sales.
You don't have to be a seasonal business to invest in future growth. When new opportunities present themselves—landing a big account that requires you to increase staff or inventory, for example, or expanding into a new market—businesses need to be able to pounce.
One caveat: Make sure the payment terms match the business need, says Christine Rico, founder of CEO on Speed Dial, a consulting firm in Brooklyn, New York that works with small to mid-size businesses. “If your company needs to finance inventory that will be converted to product and sold over the course of a year, then look for a line of credit that gives you a full year before your have to pay it down," she says. Many online lenders, she notes, start repayments right away, so would not be a good match. A better match, says Rico, would be a working capital loan that gets paid off over a year or more, or a line of credit that doesn't have a fixed repayment schedule.
Sometimes businesses find themselves short and need help to make payroll. They may hesitate to borrow money for that, but Arora, for one, argues it is a good use of a working capital loan. “It's an immediate impact," he says. “It's actually a better use than borrowing money for marketing expenses like Facebook ads or other expenses where the outcome is a lot less certain." The same goes for hiring key employees that will contribute to the company's growth and success.
Capital improvements—such as renovating your storefront or putting a better stove in your restaurant's kitchen—are also a good use of working capital. However, make sure to use the appropriate financing. For example, if you own your building, a loan that uses the property as collateral will be cheaper than a vanilla loan. Similarly, equipment loans that use the equipment as collateral will typically be less expensive. And deferred payments plans can split up large one-time purchases into more manageable installments.
What should business owners avoid using a working capital loan for?
Expenses that have a longer payback time than a year are probably not a good idea for working capital. When payments come due, if there is no additional revenue generated, business owners can find themselves in a cash squeeze.
And never borrow to cover ongoing losses. “If your business is losing money every month and can't afford to pay the bills, your first move has to be to reduce expenses," says Rico. “Borrowing to fund losses is just going to saddle the business with more costs and tighter cash flow going forward."
By being clear and strategic about their needs, businesses can leverage additional working capital to grow—and keep that optimism going.
Photo: Getty Images
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