Talking about your business, the main thing you need to run it successfully is capital. You need to know how much capital you need based on the business requirements. How to calculate working capital for your business is not a daunting task. Take your current liabilities and current assets, subtract the liabilities from assets, and there you have determined the requirements of your company’s working capital.
Well, it is not that easier too; you need to understand the concepts which we will put light on here. A good thing to keep in mind is that your company is less financially burdened when your working capital is on the positive side. In contrast, you are not putting it to work if your company has a good amount of working capital.
What is working capital?
When it comes to managing the working capital, you can end up in several difficulties if not taken proper care of. Whether a small business, medium or large, the requirements for capital matter differently. Analyzing working capital requires two things – the current assets and current liabilities. When you are left behind with the money after paying off all the liabilities, that is your business working capital.
The liabilities include paying income taxes, loans (small or short-term loans), payroll taxes, accounts payable, etc. Meanwhile, your business assets include cash, inventories, accounts receivables, and liquidated investments.
How do you determine working capital for business?
Focus on the operating cycle when determining working capital for your business. Here, the current liabilities are analyzed based on the total number of days they would be paid off. In contrast, the current assets are taken into account based on how much time or the number of days it takes to collect an account.
Every other small- to medium business requires working capital to manage its operating cycle. It helps in finding the inventory along with accounts receivables. Determining a working capital is mandatory and an intelligent move to curb the risks. Furthermore, you need to know your requirements to maintain the business growth.
Calculate working capital
It depends on the calculation of how much working capital a business needs. Furthermore, it depends on the type of business and the amount of finance required at every stage of operation. We take into consideration the formula to calculate working capital, which is as under.
Net working capital requirement = Inventory + accounts receivables – accounts payable
According to this formula, the need for working capital increases based on inventory and accounts receivable. Conversely, it decreases when there is an increase in the amount owed to the suppliers. It further takes us to understand the key considerations of working capital.
- Working capital is a representation of business operations, its efficiency, financial status, and liquidity.
- When you subtract the company’s current liabilities from current assets, you calculate the working capital.
- A company with a positive working capital amount can successfully handle its day-to-day operations. It is also able to take the short-term liabilities.
- The liquidity ratio, also called the working capital ratio, shows the company’s financial health. You can calculate the ratio by dividing current assets by the company’s current liabilities.
Sourcing working capital for your business
If your business needs short-term working capital, look at the different ways of sourcing it.
Factoring
Here the factoring company ensures handling your account receivables by buying them. Most new businesses look forward to this sourcing to determine their working capital needs.
Short term loans
When it comes to running a new business, you will not get qualified for a big loan from a bank. However, one can look for the short-term loan option. It helps finance your working capital needs, thereby letting the accounts receivable build-up.
Equity
Financing short-term working capital needs will require equity funds. It happens when you have started your business; however, it has not become profitable during its first year of operations. Equity funds can be sourced from personal families, third-party investors, etc.
Assistance of trade creditors
Trade creditors can come in handy when your business requires short-term working capital. However, for this thing to work, you should have a good relationship with the creditors. It is all about trust based on which your business receives such funding.
Do you need a good working capital ratio?
When it comes to running the business successfully, yes, you need to have an excellent working capital ratio. The greater the ratio, you have more funds to handle your business. However, a lower working capital ratio means your business has ended up in a liquidity crisis.
Ending Thoughts
There you have it. Just mind the working capital formula by considering the main components – current assets and current liabilities. You get better guidance to run your day-to-day business operations in the long run. Identifying working capital requirements is what you need for the business. Make sure to handle your financial metrics, thereby analyzing business operations for a profitable journey.
