Four Tips to Calculate Working Capital for Small Businesses
A company’s working capital reveals the firm’s current financial position and overall health by showing how much money is available to pay the day-to-day expenses of the firm. In general, the more working capital a business has, the less likely the company will experience financial hardships and the more likely that lenders and investors will extend company credit. Explore the following four tips that small business owners can use to calculate working capital.
Understand assets and liabilities
Before you get out your calculator, understanding assets and liabilities is essential to calculating your business’s working capital.
Assets include cash, fast-moving inventory, and prepaid expenses such as insurance and accounts receivable or money that’s owed to you by customers. Don’t forget any investments held by the business, such as money markets, stocks, and bonds that are quickly converted into cash.
Short-term liabilities are expenses that you must pay within one year, such as payroll costs, taxes, accounts payable, the money that you owe your suppliers and vendors, and other expenses such as rent and utilities.
Use your balance sheet
If your firm is already using a balance sheet, calculating your working capital is easy. Simply take your current assets and subtract your current liabilities. For example, if your small business has $10,000 in assets and $4,000 in liabilities, then your working capital would be $6,000 ($10,000 – $4,000 = $6,000).
Calculate your current ratio
If you want a closer look at your working capital, take your math a step further and determine your business’s current ratio. Your current ratio is your company’s assets divided by liabilities. As in our previous example, your small business has $10,000 in assets and $4,000 in liabilities, so your current ratio is 2.5 ($10,000 / $4,000 = 2.5).
A current ratio of 2 is generally considered a good indicator of an enterprise’s financial health, while a ratio over 2 may suggest that a firm isn’t using its assets efficiently. A current ratio below 2 may indicate that a company is unable to pay its bills and is a potential credit risk to lenders.
High-inventory, cash-based businesses such as supermarkets don’t need large amounts of working capital, while manufacturing companies that sell durable, expensive equipment do. Seasonal businesses must stockpile working capital to function during the lean times and to make sure they have enough assets in advance to buy inventory for the busy seasons.
Use a working capital calculator
Use a working capital calculator to project your business’s working capital needs for one year. A working capital calculator uses your percentage of annual growth, target current ratio, and current assets and liabilities to calculate your actual current ratio. Available reports show actual and target working capital, plus percent of growth your business can expect over the next year.
Positive working capital is essential to an enterprise’s success and a vital part of a company’s operational strategy. All small business owners should know where their companies’ working capital is to avoid excessive borrowing and past due payments, which could lead to a lower corporate credit rating.
If your company is in a deficit, consider a working capital loan from an online lender. Financing is a terrific way to harness your business’s potential, help kick off a new business, or assist enterprises going through a cash lull.
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