APPROPRIATE SOURCE OF WORKING CAPITAL 2: Equity or Debt?

Working Capital funds the cost of the labor & materials that go into the goods you sell (or the services you render) and what you use to pay for salaries, rent, office supplies, etc (i.e., your operating expenses).

If you do not put up enough money for Working Capital –whether from Equity or Debt, you will be forced to incur more debt than your business can support. You will be forced to inordinately prolong accounts payable so that you get into trouble with your suppliers. Not having adequate Working Capital will place your business in an unsustainable cycle of debt.

The basic structure of your Income Statement determines whether you should fund your Working Capital from Equity or whether you can afford to fund it from Debt. If your Cost of Goods Sold is greater than your Operating Expenses and, together, their share in Revenues result in a Net Income of 15% or less, the more prudent funding for your Working Capital would be Equity. If you fund Working Capital from Debt, the bulge in your Operating Expenses from the interest that you will have to carry from the borrowed Working Capital will result in a perennial Net Loss.

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