There comes a point in virtually every business where the availability of more cash would be ideal.
It’d be nirvana if it was generated by profits, but as we’re all aware, the real world usually marches to its own beat and not necessarily that of our businesses.
There are a number of sound reasons when the need for more capital is justified. Here are the most common:
- Catching a growth opportunity, such as a higher product-line level;
- Bridging a gap between seasonal revenue periods; and
- Capitalizing on the point where revenues have stabilized.
Incidentally, none of those justifications are applicable to startups. By definition, this data wouldn’t exist yet. Thus, borrowing money to fund a startup is rarely a wise option.
Deciding when to seed additional working capital is more a matter of current revenues than time involved. While it usually takes up to three years to confirm a consistent cash flow, there are opportunities where that can be accelerated.
The key factor is determining a viable plan of action:
- How much additional working capital is required, and
- How sustainable are the revenues to service it?
There’s a simple calculation that goes a long way toward finding the accurate amount:
- Current assets … Short-term liquidity, such as cash and accounts receivable.
- Current liabilities … Debts that must be paid within the fiscal year.
Here’s a simple example:
Now, let’s determine our working capital ratio, which is a comparison of current assets to current liabilities:
An overwhelming majority of analysts believe the optimal financial health for a business as regards working capital is a ratio between 1.25 and 2.00.
- If the ratio’s below 1.25, it’s indicating you may not have enough capital to cover your bills.
- If it’s above 2.00, you’re probably not investing efficiently in your business, as you’ve got idle money on hand serving no real purpose.
Now, to calculate the amount to request for a working capital loan, refer to the historical data of your business over the last fiscal year, project your revenues as a directly proportionate factor of your existing revenues, and …
- Calculate those against a 1.25 ratio if you want a conservative loan, or
- Calculate those against a 2.00 ratio if you want an aggressive loan.
Here’s a conservative example:
- 1 in 6 of your sales is producing one upgrade to a high-ticket purchase, which creates a revenue bundle of ($50×6)+($1500)= $1800.
- You’re averaging 4 revenue bundles/month = $7,200/month or $86,400 annually.
- Your historical data shows your engagement-to-conversions ratio can increase by a factor of 4 if you add a given software marketing program and/or a hot outsource or two you’ve researched, projecting revenues of $345,600.
- Your credit card costs will rise to $6000 while your tax payable increases to $32,000.
You’re seeking to identify a working capital loan that maintains the 1.25 ratio, so that amount will equal x.
Algebra time …
You’ve earned it, so go for it. The numbers are on your side:
- You know the size of an all-in loan package that will work for you,
- You see how it can cover additional marketing software and outsource services,
- You see what you can add to your promotional budget, and
- You have the option of tossing in something extra for your efforts.
With a solid high-ticket system, solid historical data, and your continued commitment, you’re on your way.
Keep in mind this is a very basic example. Most solopreneurs require limited physical facilities, outsource instead of hire staff, and provide digital products and/or services that can be delivered via dropshipping. In that respect, they rarely carry physical inventory.
However, if inventory is a significant element in your considerations, then turnover becomes an essential factor and must be taken into account.
Actually, that calculation is slightly less involved, ie- it’s still within the realm of simple math.
Working capital loans have many advantages, and it’s not out of the question anymore for traditional financial sources to consider them for well-performing digital businesses.
A logical funding source for online entrepreneurs to explore is PayPal. They don’t do credit checks, for example. All they want to see is four months of financials.
What’s more, if you give them a ballpark estimate of your needs, they’ll even do all the calculations for you.
If you’ve begun to build up momentum for your charge into the Dot Com lifestyle, a working capital loan may be just what you need to shift into overdrive.