Why is Working Capital Important For Your Business?
It’s probably true that every business wants more working capital. Working capital is exactly what it sounds like: capital that a business uses for daily operation. It’s an accounting term – it covers things like employee compensation and paying bills. It’s the money needed to meet your short-term payment goals and obligations.
There’s a formula for it. To get your net working capital, you subtract your current liabilities from your current assets (assets – liabilities = working capital). It’s expressable as a ratio, too – just divide your current assets by your current liabilities (assets/liabilities = working capital ratio). This gives you a ratio, and usually, a healthy ratio is anything from 1.2:1 to 2:1.
For these calculations, it’s advised you only use short-term assets like accounts receivable and the current money in your business account, along with inventory that will become cash within the next 12 months. Your short-term liabilities are your accounts payable, along with paychecks, taxes and other bills.
Why Do You Need Working Capital?
Working capital is what you need, as a business, to keep operating. If you don’t have enough working capital, you don’t have a functioning business. Working capital needs are different for different industries, especially ones that have seasonal revenue. This is why it’s important to prepare throughout the year to make sure your debts are managed, and your business has enough cash flow to operate. Bank of America gives four guidelines for figuring out if your business might need additional working capital cash flow:
- If your business has seasonal differences in cash flow – some businesses need extra money to prepare for a busy season, or to keep the business operating during the slow season. If you own a snow cone business, your peak season is during the late spring and summer. It’s likely you won’t have any business during the winter, so you might need extra working capital to get through it, or to prepare for the upcoming busy season.
- If you’re waiting for payments from customers, there are usually a few times you’ll be short cash to pay suppliers or employees. Greater working capital can fill that gap. If you’re a business that depends on accounts receivables, like a florist or caterer, working capital can help fill a gap in payment.
- Extra working capital can help you take advantage of things that could help your business in the long run. If you find a really good deal on supplies, but only if you purchase them in bulk, working capital could give you the opportunity to do so.
- Some businesses have project-related expenses, or temporary employees or contractors. If you need to take advantage of a project venture, working capital can cover the cost.
Where Can You Get More Working Capital?
So if you don’t have enough working capital, how can you find it?
The best way to make sure you have enough working capital is a business line of credit. These are less like a loan and more like a credit card, but not entirely. They usually have lower interest rates than a credit card, and they aren’t one giant lump sum, as a loan. With a line of credit, you can take out a credit limit, but only use what you need when you need it, without collecting interest on the entire limit. This makes it similar to a credit card. It’s great for working capital because it’s there right when you need it, if you take it out in advance, and it doesn’t gather interest if you’re not yet using it.
There are also working capital loans, which aren’t as ideal as a line of credit but can come in handy when and if there’s an immediate need for working capital.
Working capital can signify a measure of a business’s efficiency, liquidity and short-term health. If you need help meeting your working capital needs, contact FaaSfunds today and we can help you figure out a working capital solution.