The most efficient uses of working capital, equity, and profits

Securing funding for startups is no easy task. While there are multiple options to secure financing for your new business, most budding business owners find it difficult to amass the money without compromising their creativity, principles, or power of ownership.

Lack of efficient funding is a bane for startups as it may lead to failure in business and the death of smart ideas that could have made an impact on the market. While looking for financing options, the goal of a startup must be to find sustainable financiers that support revenue growth without hijacking your majority ownership shares.

Studies say that the most common reason for a startup to fail is its inability to secure capital. Hence, there should be proper planning and deployment of financing options that help to increase revenue and ensure cash flow for operations in the long run.

Ideally, a new company must explore all available funding options to become more secure and profitable quickly. Some of these financing options include working capital, equity, and profit financing.

Now, you must be aware of these terms and their significance for a startup. However, it is essential to know how to utilize these options efficiently for the growth and sustenance of your business.

In this article, we will explore these three types of financing and how to make them work best to suit a budding business.

Working Capital Financing

Working capital is defined as the capital of a business that is used in its daily operations. It is a financial metric calculated as the current assets minus the current liabilities of a business. The working capital represents the operating liquidity of the business, thereby providing a number for the capital that is available for its day-to-day trading operations.

How to Use Working Capital Financing Efficiently

The best use for working capital financing is for immediate investments, like expenses related to marketing and inventory. Since the money is readily available, this financing option is convenient and instantaneous. Its remittances are also based on a percentage of your daily sales.

Another advantage is that you do not have to give up equity or ownership shares to make use of this kind of financing. Hence, it paves way for future profits and keeps your rights within the company intact. Here’s how working capital financing can be used in your business.

  • It can be used to pay for purchase orders (POs) or inventory before selling the stock or turning a profit. Since these funds are practically in the business’s bank account, they can be used upfront to place urgent orders or complete crucial tasks.
  • Marketing and advertising activities for new products or launches can be conducted with the working capital. This ensures you do not run out of funds while trying to build a brand image and secure new customers.
  • Working capital covers business operation costs that are needed before you start making a profit. For startups especially, this kind of finance is crucial as they must spend on things like ads, stock, subscriptions, etc., before starting actual operations.

The best way to manage your working capital is to look for finance options that are revenue-based. Instead of taking out loans with high interests, try looking for flexible financing options that do not drain out the funds of your business.

In revenue-based funding, you pay from the cash inflow through your daily purchases instead of paying a fixed amount periodically. This helps you to balance cash flow and recover operations even if sales are down. For instance, if you do not sell any product on a particular day, you do not have to pay up anything.

Equity Financing

Equity financing is the process of raising funds for a business by selling shares or company stock in exchange for cash. It meets the liquidity needs of the company by offering the ownership of assets that may have debt or liabilities attached to them.

Equity financing works best for long-term profitable solutions and gives the greatest revenue returns over a period of time. However, equity denotes ownership in the company as you are selling ownership shares to raise capital. Hence, if you are worried about sharing ownership rights, equity must be harnessed up to a limit.

Using Equity Financing Efficiently

Since equity financing leads to technically giving up ownership stocks of your company, you must know how to use it efficiently. For instance, should you choose equity financing to pay for a television or internet ad? Probably not. But would you use it to launch a revolutionary product? Yes, that seems worth it.

The bottom line is that you should use equity financing for activities that would influence the company’s future growth, value, and revenue position. Here are some examples.

  • Use equity financing for investments related to research and development of new products, technologies, and services that may lead to huge business growth.
  • It is safe to use equity for operations that will take a long time, such as a year or more, but will lead to significant advancement of the company and an additional revenue source.
  • Equity finance can be used for urgent hiring tasks, infrastructure development, and future-proof investments.
  • It is the best finance option for market expansion. Since tapping into a new market requires major time and investment, it is a good opportunity for choosing equity.

This kind of funding can be managed best by raising capital through equity shares. It may seem worrying, initially, to dilute the ownership of your business. However, choosing not to invest in equity may lead to a lack of capital and a financial crunch in the long run. This will impact the growth and even survival of the business.

Profits Financing

Profit, as you know, is the financial benefit remaining when the amount of generated revenue is greater than the company’s expenses, costs, and taxes. If your business is turning a profit, you can use it for financing your operations in a smart way. By strategically investing profits as a financing solution, you can provide efficient solutions to cash woes.

How to Invest Profits Effectively

The most efficient investment of profits is directing it back to your company. You can reinvest the surplus cash into crucial operations or direct them to required expenses. This way, it creates value for your business and also saves you from going into debt.

Some ways to reinvest profits are as follows.

  • Invest profits into areas of expansion and growth. By relying on company funds instead of outside financers, you can get a greater share of the returns and also expand your business without taking loans.
  • If you have already taken loans, use your profits to pay them off. This ensures your business remains profitable in the long run and your ownership or revenue is not compromised.
  • A stable company can use profits to offer dividends to shareholders.

The way to reinvest profits depends on the size, scale, and age of a business. If you are running a new business that needs regular funds for growth and expansion, you should use all your profits to secure the company’s future and pay for beneficial assets.

On the other hand, if your business is mature and stable, profits can be used as rewards for employees and shareholders. It should also be kept aside conservatively to create a cash bank for sudden needs. 

Balance Is the Key!

While each financing option offers varied benefits, the right way to run your company is through a steady balance of all three. Use your working capital for overhead costs and daily expenses, while keeping equity measures for more long-term and sustainable growth. Both these financing options will lead you to drive profits for your business.

Once you start making profits, reinvest it based on company needs and future planning. Avoid bootstrapping (steering clear of outside financing) by combining equity and capital financing so that you can find the best supplier terms and remittance rates.

Each business has a different formula for stability and success. Hence, tailor your own financing model by combining these three financing methods and implementing them effectively for long-term growth.

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