Understanding your working capital is essential to maintaining healthy finances. Your working capital is the money you use in your day to day operations and is often used as a measure of a business’s overall financial health.
Working capital is calculated using the following formula:
Working capital = current assets minus current liabilities
Your assets include your current inventory (or stock), your receivables (money owed to you), and your current cash. Your liabilities include your outstanding creditors, your overdraft, and VAT.
This means that working capital is directly affected by the way you collect payments, manage your inventory, and pay your own suppliers.
What Happens When Working Capital Runs Low?
Low working capital is a frequent problem for businesses, even profitable ones. The intricacies of cash flow mean that working capital can run low at certain points of the month.
This can cause problems in multiple areas:
Businesses experience problems paying suppliers and banks
Working capital is necessary for paying suppliers for their goods and services, and paying banks for any current financing. Paying these parties on time is essential for efficient running of the business, and failure to pay may mean that suppliers withhold essential goods until the debt if recovered, or add on extra charges.
Even slow payment could result in suppliers requiring quicker payment times in future, further exacerbating the problem as businesses find it harder to pay.
Businesses experience problems attracting investment
Investors often look at working capital to gauge whether a business has the ability to pay back a financing. If a business has low working capital this may be a sign that they aren’t making enough money to pay back a financing in future, which increases the risk of the investment. Businesses considering seeking future investment should first ensure they have sufficient working capital.
Improving Working Capital With a Working Capital financing
Working capital often has a compounding effect – when you don’t have enough of it, running your business gets harder and harder, but with the right amount of working capital businesses can not only survive, but thrive. Businesses can take advantage of new opportunities, get further investment, and continue to grow.
A working capital financing can allow businesses to access these advantages despite their current financial situation, opening the way for further growth.