Working Capital Lending Defined

Excerpted from "What Every Lender Needs to Know About Working Capital Lending"

Generally speaking, most businesses are set up to create profits. However, many times in the environment in which businesses operate, different components that affect the business cycle can cause the realization of actual cash to become difficult, if not non-existent. For many businesses, the combination of these components creates a situation where the actual cash needed to pay the supplier is not received until the consumer pays for the finished good item(s).

Many times, businesses are forced to juggle to compensate for their cash flow gap. Interestingly enough, lenders indirectly solve this problem all the time. They often provide working capital lending without realizing it. For example, they may provide a working capital loan known as covering an overdraft, where the business owner writes a check to the supplier overdrawing the account, and the lender, knowing that someday soon the consumer payments will be received, elects to go ahead and cover the overdraft, usually for a small fee.

If the cash flow gap is not covered, the business eventually dies. Working capital lending is designed to eliminate the cash flow gap.

Working capital lending encompasses an entire spectrum of products that range from accounts receivable selling, purchase by the lending institution commonly known as factoring, all the way to lines of credit, which are a very common financing tool provided to businesses.

There are many different types of working capital financing methods. The method that is most common in Europe and throughout the world is accounts receivable factoring. This is where accounts receivable are sold to lenders who in essence advance funds to the business creating the cash necessary to fund the cash flow gap. When set up properly, these "loans" self liquidate directly to the lender under the lender's supervision.