Definition of Working Capital, Working Capital Loan, And Working Capital Financing

The layperson’s understanding of working capital, working capital loans, and working capital financing is very fussy. In fact not a single non-financial personal will be able to give anywhere close to the definition of working capital.

Here’s a simple exercise for you. Take a walk downtown with a microphone in hand. Ask the first one hundred people you come across what "working capital" is. Chances are the majority of them will be able to give you some idea as to what working capital is. And, I’m sure you probably (have an inkling about) know what working capital is, Right?

But, if I were to ask you for the definition of working capital, would you be able to tell me? Okay. Enough of the exercise. I’m going to give you the answer right here. Sadly, the average person almost always gets it wrong.

Working Capital is technically defined as the difference between Current Assets and Current Liabilities, i.e., "Current Assets-Current Liabilities," and is also know as Net Working Capital.

The working capital of a company reflects its ability to meet its obligations as they come due, and thereby avoid bankruptcy. Thus, the amount of working capital may influence the character and scope of the business. Working capital loans or financing are the funds usually required to finance working capital short-falls.

It is believed in some finance sector that the financing difficulties for small businesses only increase when they seek funds for working capital (operating expenses, purchasing inventory, receivables financing). The reason? They say, unlike a loan for the acquisition of fixed assets (land, buildings, machinery and equipment), a loan for working capital does not provide the lender with collateral thought to be as reliable for repayment purposes.

You see, new and small firms typically find themselves in working capital crunches. Without adequate working capital, they cannot build inventory or purchase raw materials. Without adequate inventory, the company cannot sell a sufficient number of products to improve its financial condition. If a sufficient level of financing is not available, the company may either collapse or never realize its true potential.

Thus, the availability of credit is a key determinant in the ability of small firms to expand and grow. To lessen these problems for small and new businesses and meet the demand, some private lenders have instituted flexible working capital loan programs. In fact some lenders offer collateral or "promise of repayment" to back up working capital loans.

Such arrangements with this new market involve third party entities (usually private lenders) who promise repayment of a loan that is obtained from lending institutions for working capital purposes. By reducing the lender’s risk, this promise of repayment increases the likelihood of the business obtaining a working capital loan, and getting the loan at affordable rates.

This is indeed a creative working capital solution. Some professionals are beginning to call it "the working capital sub prime market." Many small business owners are rushing to take advantage by going through this back door (new market) to meet their working capital needs.

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