How to Determine Your Working Capital Needs
When it comes to working capital, every business is different . Some need more working capital than others. When determining your working capital needs, you should consider the following:
1. What is working capital?
In simple terms, working capital can be calculated by subtracting your current assets from your current liabilities. Current assets are a business’s assets that are the most liquid (which means they can quickly and easily be converted to cash). Liabilities on the other hand, are debts and obligations that are due within one year. When finding the difference of these two, what you have left is your working capital. According to the SBA.gov, “Working capital is available to pay your company’s current debts and represents the cushion or margin of protection you can give your short-term creditors.” (www.sba.gov).
2. Why is working capital so important?
Working capital is essential for your business to meet its continuous operating needs. When working capital is readily available, businesses are able to pay their short term debt obligations and maintain financial viability. If your current assets do not exceed your current liabilities, you run the risk of being unable to pay short term creditors in a timely fashion. Businesses that are seasonal or cyclical often require more working capital to stay afloat during the off season. Even though your company may make more than enough money yearly to stay in business, they must be sure to have enough money at any given period of time to meet their debt obligations. The SBA.gov gives a great example of how this rule applies, “For example, a company may do significantly more business over the holidays, resulting in large payoffs at the end of the year. However, the company must have enough working capital to buy inventory and cover payroll during the off season as well, when revenues are lower.”
3. How much working capital do I need?
After you’ve calculated your working capital, you can begin to understand your needs. Although it is difficult for a business to calculated their exact working capital needs, it is always helpful to have a rough estimate. Mark Herschberg, the CEO of Zeplnvest, a new-media investment services company says, “Most people seriously underestimate what they think they need. You always have to prepare for the worst-case scenario.”
In order to calculate (or estimate) how much working capital you need, Herschberg says you must consider the following things:
- The industry you are operating in
- Your business’s growth rate
- Where you are in the lifecycle of your business
All of these factors will play a part in determining your working capital needs. A more useful tool in determining your needs is the operating cycle. The operating cycle looks at accounts receivable, inventory and accounts payable in terms of days. So, let’s define all of these parts. First, accounts receivable is determined by the number of days it takes to collect an account. Inventory on the other hand is determined by the average number of days it takes to turn over a sale. Lastly, accounts payable is determined by the number of days it takes to pay a supplier invoice. “The key to positive and efficient working capital is: to be able to fully finance the operating cycle (accounts receivable days + inventory days) with accounts payable financing alone.“(Forbes, 2013).
4. What if I’m in need of Working Capital?
Consequently, additional working capital is needed in a lot of different situations. The shortfall is typically covered by the net profits generated internally but in a lot of cases, externally borrowed funds are needed to get a business through it’s hard times. Most businesses need to borrow money at some point. However, obtaining working capital from banks can be difficult and frustrating for a business owner who is simply looking for short term working capital to see them through a slower period in their business’s life cycle.
Liberty Capital Group, Inc. has come to rescue of many revenue generating business who need assistance with working capital and cash flow. As mentioned before, working capital is the blood of your business and can make or break its future. Liberty offers generous loan amounts that are designed for small business owners seeking short-term business loans.
By: Lauren Rockwell, a business writer and works on the marketing staff at Liberty Capital Group, Inc. She writes about the latest business trends and industry conditions, from international economics to small business funding and financing. Her blogs are intended to offer accurate and concise advice to readers.