Working capital is a fundamental aspect of a healthy business. Understanding what it is and how to maximise its use is critical for the successful running of a business. Any business can fall on hard times so to know that your business could withstand this by being aware of its working capital and cash flow is very important.
Working capital is calculated as current assets minus current liabilities. This will equate to the amount of cash and assets a business has available after all liabilities are accounted for, so the money available to meet current, short-term obligations. Business owners should always be aware of their working capital to make sure that they can cope with a loss or unexpected financial issue. Simply put, the working capital formula is current assets - current liabilities = working capital.
Net working capital is often used to refer to the same thing as working capital, however, they are not the same. NWC doesn’t consider cash and current debt.
Working capital management is a business strategy. It involves making sure that a business operates as efficiently as possible by using and monitoring its current assets and liabilities effectively. This will ensure that they can maintain sufficient cash flow to enable them to pay their operating expenses and short-term debt obligations.
Every single business has a working capital cycle whether the business owner manages it well or not. It refers to the time given for a business to turn net current assets into available cash. The length of the working capital cycle is completely dependent on how you run your business. For example, if you have a two-week deadline for invoices being paid, you should receive your payment within this time frame and the cycle will be short. By not stating when your invoices need to be paid, customers might take a long time to pay you, making your working capital cycle much longer. Paying your bills for your assets as soon as you receive them will also contribute to this.
There are three main steps in the working capital cycle. These are:
For example, a heating engineer needs to fit a boiler for a customer:
The working capital cycle has been two weeks long.
Working capital ratio is your total current assets divided by your total current liabilities. The ideal working capital ratio is generally considered by analysts to be between 1.5 and 2.12 and it is important to compare a business’s metrics to those of similar businesses in the same industry.
Negative working capital means that assets are not being used effectively and the working capital cycle is not working efficiently. This may lead to:
If your working capital is not working in your company’s favour, there are always ways you can improve it. These include but are not limited to:
If you need some financial assistance to make your working capital more efficient for your business, a working capital loan is for you. We understand that sometimes companies run into unexpected problems and you may need a loan to assist you to get your working capital cycle working to your company’s advantage. We have access to over 100 lenders and can talk you through the process to ensure we are meeting your needs.