Working capital affects many parts of your business, from paying suppliers and employees to paying rent and planning for long-term growth. Working capital is the money available to meet your current, short-term obligations and is essential to any business’s immediate and long-term success. To make sure your working capital works for you, you'll need to know how to calculate your current levels, project your future needs and consider ways to make sure you always have enough cash. This Union Commercial Capital blog post will help you better understand working capital and it's impact on your business.
What is Working Capital?
Working capital is essential for your business to run properly. In short, working capital is the money available to meet your obligations. It affects many aspects of your business, like paying employees, vendors, and bills. To make sure your working capital works for you, you'll need to calculate your current levels, project your future needs and consider ways to make sure you always have cash.
Your Business’s Financial Health
Being able to pay your bills and having cash available to put back in your business are signs that your business has good financial health. This also shows that your business is operating efficiently and profitably and, as a result, is less vulnerable to losses that can result from slow sales periods or unexpected downturns. Essentially, the more working capital you have, the healthier your business will be.
Calculating Working Capital
To calculate working capital, all that you need to do is subtract your business’s current liabilities from its existing assets. Then, you can find your liabilities and assets listed on your balance sheet. Liabilities are short-term debts that you need to pay off within the next twelve months, such as payroll taxes, credit card balances, and short-term business loans. Assets are items of value that your small business owns or benefits from, such as working capital, inventory and equipment.
To illustrate the formula, let us say that a hotel has current assets of $400,000 and current liabilities of $200,000. Subtracting the liabilities ($200,000) from assets ($400,000) is $200,000, the hotel’s amount of working capital.
Working Capital Ratio
With good financial planning, your small business can eventually have more cash and short-term receivables than short-term debts, enabling you to pay off your liabilities and save for the future. This is referred to as positive working capital. On the other hand, if your small business owes more money than it currently holds, it has negative working capital.
Calculating your business’s working capital, provides valuable insight into your business’s financial health. You can take your analysis a step further by calculating your working capital ratio.
Positive Working Capital: Positive working capital is when the value of the company's current assets is greater than its current liabilities. This means the company has sufficient cash to cover its obligations.
Negative Working Capital: Negative working capital is when a company's current liabilities exceeds its current assets. This means that there is more debt than assets available to pay it off.
How to Increase Your Working Capital
No matter what your industry you're in, the three things that affect your net working capital are:
Your Stock
Your Receivables
Your Liabilities
The relationship between these factors decides your working capital. To improve your working capital, you need to adjust 1 or more of these factors so that you can retain more cash. You need to closely monitor many aspects of your business’s financial structure and make sure you are doing everything possible to maintain a positive cash flow. Strategies to help increase working capital include consolidating business debt, improving your inventory management system, and working with vendors and suppliers who offer better pricing.
4 Reasons You Might Need Additional Working Capital
Seasonal differences in cash flow are typical of many businesses, which may need extra capital to gear up for a busy season or to keep the business operating when there's less money coming in.
Almost all businesses will have times when additional working capital is needed to fund obligations to suppliers, employees and other debts while waiting for payments from customers.
Extra working capital can help improve your business in other ways, for example, enabling you to take advantage of supplier discounts by purchasing in bulk.
Working capital can also be used to pay temp employees or to cover other project-related expenses.
Investing time and effort in managing working capital is essential for your small business's success and health. It might not sound as nice as profit, but it is the money your business requires to meet day-to-day expenses and seize opportunities for growth.
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