Working capital is the difference between a business's current assets, such as cash, receivables and inventory, and its current liabilities, such as payables and short-term debt. It indicates how much the business has available to fund daily operations.
How it works in factoring
Working capital = current assets minus current liabilities
Illustrative example: A distributor has $50,000 in cash, $220,000 in receivables and $130,000 in inventory, for $400,000 of current assets. It owes $260,000 in payables and short-term debt. Working capital is $140,000.
Positive working capital does not guarantee enough cash on hand. In the example above, most current assets are tied up in receivables and inventory. If suppliers want payment before customers pay, the business may still be short of cash.
Factoring changes the mix of working capital rather than creating new assets. It converts receivables into cash sooner, minus a fee. That cash can then be used to buy inventory, meet payroll or take on larger orders.
Other working capital financing tools include:
- Bank lines of credit
- Asset-based lending against receivables and inventory
- Purchase order financing for specific orders
- SBA working capital programs such as CAPLines
Why it matters
Growing businesses often need more working capital, because larger sales mean larger receivables and inventory to carry. Understanding your working capital cycle, the time from paying suppliers to collecting from customers, helps you pick the right financing and size it properly.