What is a Working Capital?
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.
How to Calculate the Working Capital Need of Your Company?
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:
Current assets / Current liabilities = Working capital ratio
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:
Current assets – Current liabilities = Net working capital
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.
