Working Capital is a financial terms that every small business owner needs to understand. Unfortunately it may sound foreign to a lot of small business owners.
What does working capital mean?
Understanding the technical meaning of working capital is as important as understanding its role in your businesses financial planning, as well as how the ability to obtain it or not can affect your business.
Now, what is a working capital? What is the formula?
Working Capital = current assets – current liabilities
This formula measures the company’s short-term liquidity and is important for managing cash flow. It is a financial measure that calculates if a company has enough liquid assets to pay its bills that will be due in a year. If a company has excess current assets then that amount can be used to spend on its daily operations. Any ration under 1 is negative working capital, over 1 is positive working capital.
What is a current asset? It is cash and equivalents, inventory, accounts receivable, and marketable securities. These are resources a company owns that can be used up or converted into cash within a year.
What is a current liability? It is the amount of money a company owes. This includes accounts payable, short-term loans, accrued expenses which are due for payments within a year.
If you have positive working capital it’s an indicator that your small business is financially healthy for the short term. In other words, your business has an adequate amount of cash to manage your business and fund growth . Negative working capital indicates that the company is not using its assets effectively and it could lead to a liquidity crisis. In some instances negative working capital can be ok. For instance, a company that concentrates on selling to individual customers at the time of purchase can easily function without much working capital compared to a business that needs to pay suppliers in 30 days but expects payment in nothing less than 60 days.
Having too much working capital on hand may not be the best plan because it may indicate that the small business owner does is not investing in growth. The ideal working capital ratio is from 1to 2. If the ratio is over 2 then the assets are not being invested and that will affect growth.
How does working capital help my company?
This is a question you have probably been waiting for. It helps your company or business by giving you insights on how to address your debts, how to invest that will boost the performance of your business and also provide cash for unforeseen expenses. A business without working capital opens the doors to problems that may drain the available cash and as well hinder expanding or growth opportunities.
Then, how can you boost working capital in a short term? One of the effective strategies to achieve this is a working capital loan. This entails having cash available quickly in order to meet financial requirements of different needs; it also has to do with paying the cash back according to the agreement you and the lender made.
There are many types of working capital loans and it’s important to do your research. Find the right program that works for your business and is tailored to its needs.