What is the ideal way to fund a business?

A couple of weeks ago, I asked you all about the best way to fund a business. The options were operating leverage, negative working capital, and external financing. Today, I want to share my thoughts on why I believe one of these is better than the others. Spoiler: it’s not the most popular choice from the poll which, was external financing.

The best way to fund a business, in my opinion, is through negative working capital.

I know this might not be the easiest source of funding to secure, so if you can’t manage it, the second-best option is operating leverage. On the other hand, the most popular choice, external financing, is actually the least favorable. You should only consider external financing if the other two options aren’t generating fast enough growth. If your business can’t achieve some growth on its own before seeking external financing, then it might not be ready for it.

Negative working capital works wonders when combined with operating leverage, but it can also deliver impressive results on its own. Together, they create a powerful effect on a business’s organic growth.

Let’s break down what these terms mean. Operating leverage happens when your revenue consistently grows and stays higher than your costs of goods sold (COGS). Negative working capital means your revenue stays in the company longer because your payables (what you owe) are delayed compared to your inventory and receivables (what others owe you).

For example, consider Gym Shark, a clothing manufacturer. Their receivables days are zero, meaning they get paid immediately, and they buy inventory just in time. Meanwhile, they pay their suppliers 30 days later. This means their revenue is available to boost the business every 30 days, providing a continuous cycle of funding.

This setup also enhances operating leverage because it increases the revenue/COGS ratio each cycle. For businesses like this, external financing could actually be harmful due to the burden of debt repayment.

In conclusion, the best way to finance a business is by maintaining a negative net working capital cycle. This method keeps your revenue working for you and can significantly enhance growth without the downsides of debt.