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Funding a Small Business: How Much Working Capital Loan is Needed to Start a New Small Business?

Funding a Small Business: How Much Working Capital Loan is Needed to Start a New Small Business?

Guest Post | @indiablooms | 28 Jun 2018, 04:42 am

A mere Rs.10,000 working capital from the hands of Sudha Murthy led to the foundation of a $10 billion company – Infosys. In its truest sense, working capital refers to the trivial amount necessary for the efficient functioning of a business.

The working capital of any venture is calculated by subtracting current liabilities from current assets. Where current assets are short-term and are convertible into cash, current liabilities are debts that need to be paid off typically within a year.

For start-ups, the working capital needs may vary with the business size and production capabilities. On the other hand, for business expansion, individuals can use such funds for buying/upgrading new equipment, debt consolidation, expanding to a new location, addressing cash flow constraints, paying taxes, or even improving their credibility. Bajaj Finserv is one such NBFC that caters to working capital requirements faced by companies.

Numerous entrepreneurs opt for a working capital loan whether it is for establishing a business or expanding it. However, while seeking such a loan, business owners must pre-plan the proper utilization of working capital.

How to determine working capital for a small business?    

When starting a new business, experts recommend subtracting the current liabilities from the current assets incurred for at least 1 year to determine the average working capital.

Current assets may include cash, inventory, stocks and bonds, and accounts receivable. Current liabilities may include payments like interests, debts, rent, wages, raw materials and other supplies used during the 1 year period.

Determining the inventory and raw materials may be critical as it depends on the following:

1. Business priorities and size

For example, when setting up a paper mill, a business owner will require various types of machinery. These include paper machine headbox, paper machine press part, MG cylinder, pope reeler, rewinder, and others.

Thus, in this case, the volume of working capital loan required will be on the higher side. Also, a paper mill will require a large property for setting up all these machinery.

On the other hand, if establishing a waffle shop, one only needs few waffle irons and trained employees. The size of its property required will also be limited in this case. However, if an owner wants to set up multiple shops, then the amount of the working capital loan will increase.

Also, an owner will need to hire more personnel and also train the inexperienced ones.

Further, when expanding, one has to invest considerable amount in a paper mill; but, for a waffle shop, the investment will be low.

2. Operating cycle

The operating cycle begins when a business owner buys raw materials and converts them into the final product. This final product generates revenue and the longer it takes to produce, the larger will be the working capital loan required.

The paper mill will require substantial raw materials while the waffle shop, only a few ingredients.

In addition, owners need to ensure that the operating cycle doesn’t come across any obstacles and goes on effortlessly. Any hindrances in its operating cycle will increase the working capital requirement.

Further, even after production of the final product, if revenues don’t come in accordingly, it might create significant issues. For example, vendors providing a line of credit may reduce their due dates and even stop doing business with an owner.

So, it becomes crucial to understand the various barriers a business may face during its operating cycle before determining the working capital financing.  

3. Fixed costs

Business owners need to assess their fixed costs before arriving at the working capital required. Fixed costs include all the expenses required by a business on a daily business even if the revenues don’t come in.

In addition to rent, a waffle shop will require storage facilities to ensure that ingredients don’t rot. On the other hand, a paper mill might not require such storage units for its raw materials.

Bajaj Finserv is one such NBFC that offers affordable working capital loan interest rate thereby making these loans convenient to avail. So, depending on the above mentioned intricacies, a business owner has to determine the amount of working capital loan required.