Working capital is an accounting term that means the capital used in your business’ day to day operations. It is calculated by deducting one’s current liabilities from one’s current assets, and is a key factor to your business' success. Most of the aspects of your business are affected by working capital. Not only to run your business smoothly but to plan and execute the advancement of your business, you must have an insight into your working capital. Every business has a working capital need that varies according to numerous factors. Since it is primary to operating your business, you need to know how to calculate your working capital needs.
Working capital is what pays your vendors, employees, electricity, etc. and helps your company's growth. Working capital expedites and accelerates your business' effortless functioning and provides you with a proper idea of your company's liquidity position.
To put it simply, the funding available with which all your present and short-term business obligations are met by working capital. Nevertheless, there comes a time where working capital is a need for financing. Therefore, it is very crucial to evaluate your company's working capital.
Working capital requirement depends on several factors. While evaluating your firm's working capital need, you need to consider the following:
Type of business
Scope of the company's operations
The working period of converting raw materials to finished goods
Credit terms and the total sales which were made on the credit
Seasonal changes in seasonal businesses
Financial cushion for contingencies. For instance, your company is in instant need of cash.
It is always better to be aware of your company's financial health. Planning strategically is what can lead your business to success which is why you must be informed of your working capital. Since the working capital requirement depends on many factors, you can calculate where you stand by evaluating your working capital ratio.
The working capital ratio is the assessment of your business' short-term fiscal health. The formula to calculate your working capital is:
To know how much funding your company readily has as of now, you can calculate your net working capital. The formula to calculate your net working capital is:
While calculating working capital using any of the above formulas, you should include only your short-term assets. Short-term assets include the money in your company's account, money that you're yet to receive from your customers, and the raw materials that you can convert to fund in the next year. Short-term liabilities mean the money that you still owe to creditors and vendors, any debts, other outlays, and taxes.