Small and medium business owners must understand their cash flow needs not only to stay competitive and grow their sales but to stay in business. One of the most important concepts for your finances is having adequate working capital. But what is working capital and how do you calculate it?
What Is Working Capital?
The official definition of working capital is the amount by which your current assets exceed your current liabilities. To put it in simpler terms, working capital is the money you have readily available to spend on your business operations after covering your expenses. It’s important to have sufficient working capital on hand to pay your bills until you can collect on your receivables.
How to Calculate It
The most accurate way to determine what your working capital needs are is to look at your operating cycle. You’ll need to understand how long it takes to collect payment from your customers (accounts receivable), how long it takes to sell the inventory that’s located on your premises, and how much time you have until you have to pay your suppliers (accounts payable).
In most cases, there is a stretch of time where your inventory is already at your customer’s location and the supplier demands to be paid, but the customer has not paid you. That’s where your working capital comes into play, allowing you to continue operations and meet the temporary cash crunch at the same time.
Your working capital needs may vary throughout the year. For example, many retailers stock up on inventory in the months before the holidays but won’t pay their suppliers until the end of the year. In the meantime, these suppliers still need money to function as operating expenses continue to accumulate, so if they don’t have adequate working capital to see them through this period they could face serious problems.
How to Obtain Enough Working Capital
Most companies can’t finance their operations using personal funds, supplier credit or invoice factoring alone. Instead, they apply for a working capital loan in Roswell, GA. A working capital loan allows your business to meet its short-term cash needs without risking your relationship with your suppliers or customers.