How to Improve Working Capital During High Inflation
How business owners can anticipate rising costs to help their businesses grow during challenging times.
With high inflation and interest rates rising rapidly, making sure that you have adequate business working capital should be a first order of business. Whether you’re paying your vendors and employees, investing in automation or other improvements, or just keeping up with your bills, you need cash on hand. With interest rates going up, it’s more important than ever to make good choices about how and when you borrow money and how you put it to use.
Here’s how to improve your working capital.
Calculating Your Working Capital Needs
You probably already know the basic working capital terminology. To calculate your net working capital, subtract your current expenses or liabilities, usually projected for the next 12 months, from your current assets. Your working capital ratio, a metric sometimes used to gauge the health of a business, is current assets divided by current liabilities. Depending on your industry and other factors, a good working capital ratio might range from 1.5 to 2.
Determining these numbers for your business may be fairly straightforward. Your assets include cash, current accounts receivable, and the value of your inventory. On the other side of the ledger is what you owe to suppliers as well as the costs of keeping your doors open. Employee salaries, rent and utilities, tax payments, company debt, and interest costs all count as liabilities.
But knowing your net working capital or your working capital ratio does not answer an all-important question: How much working capital do you actually need to execute your business plan?
Part of the answer depends on what kind of business you have. Most companies experience month-to-month fluctuations in income and expenses, and many retail businesses, in particular, are distinctly seasonal. They may have to gear up production in advance of demand that spikes in the summer months or the holidays, for example, and then slow down significantly during other parts of the year. A primary purpose of working capital is to help bridge gaps in income, helping you keep up with fixed and variable expenses even when there is little revenue coming in.
Alongside such considerations, finding how much you need in today’s economic climate may mean revisiting parts of your operation that were once routine. It has been extremely hard to hire good workers in this very tight labor market, and now inflation is pushing up wages at a rate not seen in decades. Supply chain issues may continue to be a problem as well, with late deliveries and, again, higher costs. Part of managing your working capital requires projecting your cash inflows and outflows at least several months into the future. For many businesses, the future has never been less clear.
One way to respond to that uncertainty is with strategic investments. You might be able to automate parts of your business, using assembly-line robots, customer-service bots, or data-entry software, and that could eliminate the need to find and pay some entry-level employees. At the same time, you could look for ways to attract and retain the workers who are essential to your business, perhaps by offering enhanced retirement and other benefits. "You may not need as many employees for a particular task, but you need a more strategic, sophisticated employee," says Christina Nestico, Vice President of Product Management for Fifth Third Bank. "Investing in hiring and keeping the right talent, as well to meet your automation needs and make other important improvements, can pay off in the long run."
Sources of Working Capital That Fit Your Business
Once you have examined the working capital needs of your business, you can explore the different kinds of financing that can help you meet them. Often, establishing a line of credit such as through Fifth Third Fast Capital® can give you quick access to funds just when you need them. A Fast Capital line of credit of up to $100,000 doesn’t require collateral and has minimal documentation requirements. "If you need to make payroll while waiting for invoices to be paid or need to increase inventory before the holiday season, for example, a line of credit can work well," says Nestico. "Then you can pay back the money so that the credit is there when you need it again."
A secured line of credit is another option for supporting your day-to-day operations and meeting short-term obligations. A Fifth Third secured line of credit, which uses your short-term assets as collateral, offers variable rates and interest-only payments. But these days, when interest rates are trending ever higher, you might want to consider converting a line of credit balance to a term loan with a fixed rate. "If your business usually carries a balance, locking in a fixed rate now could limit your interest costs and free up your line of credit for working capital," says Nestico.
Term loans can also be used for working capital, although you’re more likely to use them to finance longer-term capital expenditures for equipment, real estate, and building projects to expand your business, Nestico says.
Another source of both lines of credit and term loans is the U.S. Small Business Administration, or SBA. SBA-backed loans, provided by Fifth Third and other lenders, may be used as working capital and for other business needs. Because of the government guarantee, these loans may be an option for companies that don’t have access to traditional financing. Although this is the Small Business Administration, "you don’t have to be particularly small," Nestico says. To qualify, a business can’t have more than $15 million in tangible net worth and must have a maximum average annual net income, after federal tax, of $5 million.
Managing your working capital is not only a matter of choosing the right loan, she notes. Using treasury management services to digitize payables and receivables, for example, can be an effective way to speed up transactions and free up working capital. Supply chain financing, also known as reverse factoring, can also make your operations run more smoothly by promising to pay invoices more quickly in exchange for a discount.
In these challenging times, you may need a combination of strategies and loan products to make sure that you have an adequate, flexible amount of working capital. But thinking about your needs and possibilities now can help you not only weather a shaky economy and persistently high inflation; it can also position your business to thrive during better days ahead.