The Importance of Working Capital for Your Business
Working capital determines the strength and viability of a company over the period of one year. The goal of most companies should be to get in a position of possessing positive available capital, which provides the ability to not only meet the company’s expenses but positions it for growth.
For some companies that find themselves in a negative cash flow situation, they may have to result in more borrowing to cover operations expenses and late payments to vendors. This is a bad situation as it will ultimately result in a lower credit rating.
Companies that do well despite negative capital are those that have high inventory due to consumer demand. These companies would include retailers and restaurants who have a steady stream of cash flow. As a result, they require less working capital.
Other types of companies, such as those that produce heavy equipment or niche products with a high price tag, don’t have the high consumer demand of retailers and restaurants due to the affordability of their product. This results in a slower flow of incoming cash as ales are slower and when they do occur, they must sell their products on net terms. For these companies, excess liquid assets to cover day to day operations becomes more essential.
Your business’s available cash flow is vital to your company’s decision-making ability and financial future. A formula you can use to determine your company’s working capital is to subtract your current liabilities, which includes accounts payable, loans and liabilities, from your current assets, which are cash, accounts receivable and inventory. This formula will give you the dollar amount of any short-term liquid assets that will remain after your liabilities have been paid. This tool is useful in managing cash flow as well as projecting a financial future.
Your current assets are resources such as inventory that can be liquidated into cash in no longer than a year, while current liabilities are the money a company owes to vendors and banks which will need to be paid within a year. Having an excess of assets gives a company access to funds that can be used in its daily operations.
Calculating your company’s working capital is a vital part of your business’s operations. Utilizing a formula such as the one above will put your company in a better position for planning ahead before payments are missed and your company’s credit is damaged.