Working Capital otherwise known as Net Working Capital is the difference between a company’s current assets and current liabilities. It acts as the financial measure, which is used to calculate if a company has enough liquid assets to pay its bills that will be due within a year.
Working capital is the difference between a company’s current assets, like cash, accounts receivable, and inventories of raw materials and finished goods and it’s current liabilities, like accounts payable.
Current assets: These are things like cash and equivalents, inventory, accounts receivable, and marketable securities, which are resources a company owns which can be used up or converted into cash within a year.
How to Calculate Working Capital
Working Capital Formula
Current assets / Current liabilities = Working capital ratio.
Net Working Capital Formula
Current assets – Current liabilities =Net working capital.
Net Working capital helps you to know how much money you have readily available to meet current expenses.
Reasons Why Your Business May Need Additional Working Capital
Extra working capital can come in handy when you need to improve your business in other ways, like helping you to take advantage of supplier discounts by buying in bulk.
Some businesses experience seasonal differences in cash flow, and this may necessitate the need for extra capital to stay prepared for a busy season or to keep the business operating when there’s less money coming in.
When you need additional capital to fund obligations to suppliers, employees as well as the government while waiting for payments from customers.
How to Qualify for a Working Capital Line of Credit
Lenders will also examine your financial statements, credit score, as well as tax returns and you, will also be asked for a personal guarantee of repayment. Thus make sure all these things sorted out before you begin.
As a rule of thumb, the size of your working capital should not exceed 10% of your company’s revenues. This is because high working capital is not always a good thing. After all, it might indicate that the business has too much inventory or is not investing its excess cash.
Changes in Working Capital That Can Affect a company’s Cash Flow
Some major new projects, like expansion in production or into new markets, need investment in working capital. This reduces cash flow. Although cash will also fall if money is collected too slowly, or if sales volumes are decreasing, which leads to a fall in accounts receivable. Companies using working capital inefficiently can boost cash flow by squeezing suppliers and customers.
Options For Boosting Your Working Capital
To boost your working capital, you might consider an unsecured, revolving line of credit, which can be an effective tool for augmenting your working capital. These lines of credit are designed to finance temporary working capital needs, terms are more favorable than those for business credit cards and your business can get what it needs when it’s needed.