SELECT YOUR LANGUAGE

Working capital is said to sometimes hold the key to your company’s success. Working capital affects many aspects of your business, from paying your employees and vendors to keeping the lights on and planning for sustainable long-term growth.  Working capital is the money available to meet your current, short-term financial obligations. To make sure your working capital works for you, you’ll need to calculate your current levels, project your financial future needs and consider ways to make sure you always have enough cash.

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To calculate working capital, you can get a sense of where you stand right now by determining your working capital ratio, a measurement of your company’s short-term financial health.

Working capital formula:
Current assets / Current liabilities = Working capital ratio

For example: 
If you have current assets of $1 million and current liabilities of $500,000, your working capital ratio is 2:1. That would generally be considered a healthy ratio.
Your net working capital tells you how much money you have readily available to meet current expenses.

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Net working capital formula:
Current assets – Current liabilities = Net working capital

For these calculations, consider only short-term assets such as the cash in your business account and the accounts receivable; the money your customers owe you and the inventory you expect to convert to cash within 12 months.

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Short-term liabilities include accounts payable;  money you owe vendors and other creditors as well as other debts, and accrued expenses for salary, taxes and other outlays.

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Getting a true understanding of your working capital needs may involve plotting month-by-month inflows and outflows for your business.  The revenue generated and the expenses you pay out are examples of inflow versus outflow.  It can be particularly challenging to make accurate projections if your company is growing rapidly or not generating much revenue.  Financial projections can help you identify months when you have more money going out than coming in, and when that cash flow gap is the widest.

An unsecured, revolving line of credit can be an effective tool for augmenting your working capital. 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 draw only what it needs, when it’s needed.

While a business credit card can be a convenient way for you to cover incidental expense, and other needs, it’s usually not the best solution for working capital purposes. Limitations include higher interest rates, higher fees for cash advances and the ease of running up excessive debt.

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Many factors may affect the size of your working capital line of credit, a rule of thumb is that it shouldn’t exceed 10% of your company’s revenues.  A banker or loan officer can help you better understand your working capital needs and what steps you need to take. While you can’t predict everything about running a company, a clear view of working capital can help you operate smoothly, if you use the funds wisely.

 

By Jason Torrents