Tech, ExplainedFintech
Concept

Working capital

Paying now, paid in ninety days.

HOW IT WORKSThe business buysmaterials andpays its workersIt makes the goods anddelivers themIt sends an invoicethat allows 30 to 90days to payWhile it waits, itscash is tied up, and aloan can fill the gapThe customer pays, andthe cycle starts againCosts are paid now and income arrives later, so even a profitable business needs cash in between.HOW IT WORKSThe businessbuysmaterialsand paysits workersIt makes thegoods anddelivers themIt sendsan invoicethat allows30 to 90days to payWhile itwaits, itscash is tiedup, and aloan can fillthe gapThe customerpays, andthe cyclestarts againCosts are paid now and income arrives later, so even a profitable business needs cash in between.HOW IT WORKSThe business buys materialsand pays its workers↓It makes the goods and delivers them↓It sends an invoice that allows 30 to 90days to pay↓While it waits, its cash is tied up, anda loan can fill the gap↓The customer pays, andthe cycle starts againCosts are paid now and income arrives later, so even aprofitable business needs cash in between.
A business pays for materials and workers first, waits weeks for its customer to pay, and needs working capital to cover that gap in every cycle.
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Working capital is the cash a business needs to buy stock and pay its costs before its own customers pay it. A business usually pays its suppliers and workers now. But its customers often pay 30, 60 or 90 days after delivery. For those days, the business must find the cash somewhere. Accountants measure working capital as the business's current assets, which are its cash, its stock and the money its customers owe it, minus its current liabilities, which are the bills and loans it must pay within a year.

Here is how the gap appears in general. The business buys materials and pays its workers. It makes the goods or does the work, and delivers it. It sends an invoice, which allows the customer to pay later. While it waits, its own cash is tied up. When the customer pays, the business buys materials for the next order, and the cycle repeats. The longer the wait, the more cash the business needs. A business can be profitable and still run out of cash, because the cash arrives too late.

India has tens of millions of small businesses, and most of them find it hard to borrow working capital from a bank. Many have no audited accounts, no property to pledge, and large customers who pay slowly. So new lenders now decide from a business's sales, its GST returns and its payments. These are MSME loans.

Take, for example, a supplier of car parts that waits 60 days for a carmaker to pay. With invoice discounting, an investor pays the supplier most of the invoice now, and collects the full amount from the carmaker later.

Consider an exporter of spices that must buy stock before it ships. A trade finance platform arranges a letter of credit, a bank's promise to pay the exporter once the exporter shows the documents that prove the goods were shipped.

Say an online seller must stock up before a Diwali sale. With revenue-based financing, a lender advances the money, and takes repayments as a share of each day's sales.

How is a working capital loan different from a term loan? A term loan pays for something that lasts for years, such as a machine or a building, and is repaid over years. A working capital loan covers the short gap in each cycle, and is repaid when the customers pay. The difference between lenders is explained in NBFC vs bank.

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