Positive working capital is essential to the successful operation of any business. The term refers to the amount of funds available at any specific time to meet the demands of daily operation. Although it’s an accounting term, all employees should have a basic idea of what it means. This is especially true of the company owner and those in management positions. Without positive working capital, you could find yourself in a never-ending cycle of borrowing money plus paying interest just to meet your company’s everyday expenses.
The Formula to Determine Working Capital
The definition of working capital is simple enough on the surface. You add up the total assets for your company and subtract its liabilities to determine a figure. Business assets include:
- Accounts receivable: The money that customers owe your company but have not yet paid is its accounts receivable.
- Cash and equivalents to cash: This category includes such things as funds in checking or savings accounts for your business, treasury bills, and money market funds.
- Inventory: For working capital purposes, inventory is any product that you currently sell for a profit that you can liquidate or sell to obtain cash within one year.
- Market securities: Certain types of bonds, mutual fund shares, and stocks fall into this category.
Business liabilities include:
- Accounts payable: This would include short-term bills not yet paid such as rent, utilities, and employee salaries.
- Interest payments: These are the payments you must make to banks and bondholders, including interest on both short-term and long-term debt.
- Short-term debt payments typically include payments to banks and credit card companies.
- Suppliers and vendors: Debt in this category includes all money owed to other companies for providing services and raw materials.
- Tax payments: You should include income and payroll tax that your company must pay within the next 12 months.
Why You Need to Know This Figure
Besides giving you a good idea of where your business stands financially, you will need to provide its net working capital when working with business partners or applying for a loan using debt or equity financing. Many companies aim to pay off loan debt within one year to ensure that their liquidity doesn’t fluctuate too significantly. Additionally, knowing your working capital allows you to compare how well your business is doing within its industry.
How Lenders Determine Financial Stability
The higher your working capital, the greater trust you inspire in lenders that you will repay your loan obligations on time. Of course, the opposite is true if you have a negative number and little to no liquidity. Paying attention to your working capital figure is especially important if you plan to apply for business financing.
While it’s common for working capital to fluctuate based on seasonal spikes in demand and other factors, lenders prefer to work with businesses that can show a consistent pattern of positive working capital. Some financial institutions also provide working capital loans when revenue does run short, but we don’t recommend that you make a habit of relying on them.
Need More Help Determining or Managing Your Working Capital?
Business coaching is just one of several services we offer at Business Partner Alliance. We invite you to request an appointment today for help and feedback with your working capital or any other business challenges you currently face.