In the world of business, capital is king. This is the fuel that allows businesses to operate and grow. Working capital is a crucial aspect of this, as it represents the amount of cash and other liquid assets that a business has available to fund its operations. In this article, we will explain the difference between gross and net working capital and how they relate to small business loans.
What is gross working capital?
Gross working capital refers to the total amount of current assets that a business has on hand. These assets may include cash, accounts receivable (i.e., money owed to the business by customers), inventory, and other short-term assets. Essentially, it is the total amount of liquid resources that a business has at its disposal.
Gross working capital is an important metric for businesses to track, as it gives insight into their ability to meet their short-term financial obligations. For example, if a business has a high level of accounts receivable, it may indicate that they are selling their products or services on credit to customers. While this can be a good thing for the business in the long term, it may hinder their ability to meet their current cash flow needs if they are waiting for payments to come in.
What is net working capital?
Net working capital, on the other hand, considers a business's current liabilities as well as their current assets. This provides a more accurate picture of a business's ability to meet its short-term financial obligations.
To calculate net working capital, you must subtract a business's current liabilities (i.e., debts and obligations due within one year) from their current assets. If the result is positive, the business has a positive net working capital and is in a good position to meet its short-term obligations. If the result is negative, however, it may indicate that the business is at risk of not being able to pay its bills on time or defaulting on its loans.
How do small business loans work?
Small business loans are a common way for businesses to access the capital they need to grow and expand. These loans may be secured (meaning the borrower puts up collateral, such as equipment or property, to secure the loan) or unsecured (meaning there is no collateral required).
When applying for a small business loan, lenders will typically look at a variety of factors to determine the borrower's creditworthiness. This may include the borrower's credit score, their revenue and cash flow history, their business plan, and their collateral (if the loan is secured).
If approved, the borrower will receive the loan amount in a lump sum and will be responsible for paying it back over a set period, along with interest and any applicable fees. The repayment period and interest rate will vary based on the lender and the specific terms of the loan agreement.
Difference between net and gross working capital
For businesses seeking a secured business loan, there are key differences to understand between gross and net working capital. One of the primary factors that lenders will consider when determining the borrower's creditworthiness is their working capital position.
If a business has a high level of gross working capital, it may indicate that they have a significant number of liquid assets on hand. However, if they also have a high level of current liabilities, this may offset the positive impact of their gross working capital. Lenders will therefore be more interested in a borrower's net working capital position, as this gives a more accurate picture of their ability to meet their financial obligations.
In general, lenders prefer to see a positive net working capital position, as this indicates that the borrower has sufficient liquid assets to cover their current liabilities. This reduces the risk of default and makes the borrower a more attractive candidate for a loan.
In conclusion, understanding the difference between gross and net working capital is important for businesses seeking small business loans. While gross working capital may give an overall sense of a business's liquidity, net working capital provides a more accurate picture of their ability to meet their financial obligations. By having a positive net working capital position, businesses can improve their chances of being approved for a loan and provide lenders with greater confidence in their ability to repay the loan.
