Working capital is a good – but not foolproof – way to used measure a company’s financial health. If you have enough assets on hand to meet your business financial obligations for about a year, you are probably making good business decisions.
But low working capital is the business version of living paycheck to paycheck. It’s stressful, it limits your options and it can kill your business – even if your business is profitable. It’s important to understand how much working capital you need, and how to increase (and sometimes even decrease) your working capital assets.
How to Calculate Working Capitol
Figuring out how much working capital your small business has is fairly easy. Besides the cash you have in the bank, working capital includes assets that you can fairly quickly liquidize into cash such as inventory and accounts payable. From that figure, you deduct obligations that will be due within the year.
So, as an example, let’s say you have $50,000 in ready cash and current customer invoices, plus another $5,000 in marketable securities. Your current assets are $55,000.
Now deduct your obligations. For example, $10,000 in payroll, $4000 in operating expenses, and another $6,000 in supplier lines of credit. Your current liabilities are $26,000.
Divide your current assets by your liabilities to calculate your working capital ratio. $55,000 divided by $26,000 gives us a working ratio of 2.1. In general, you want a ratio of 1.2 and 2.0 – anything under 1.0 is a predictor of serious business liquidity problems, while a figure over 2.0 suggests it’s time to put you money to work making more money, so you may want to consider ways to expand the business.
A word of warning, while a quick calculation of your working capital ratio can be interesting and enlightening, before you make any decisions based on that number get a proper financial review from an accountant or a financial advisor who knows your business and can perform a comprehensive calculation of all your assets and liabilities.
How to Increase Working Capital
Since positive working capital typically indicates good business management, you should be able to increase your working capital by reducing the amount of money that is currently unavailable for use. Among the things to consider is whether you regularly overstock inventory, are collecting on your invoices too slowly, or are paying your bills too quickly. That last one surprises small business owners, who often see fast payments something to be proud of, as well as a way to improve their credit rating. But there’s a fine line between paying on time and paying as soon as a bill shows up. As long as you pay on time, you’re fine. Try to keep your assets as liquid as possible, to keep cash available to meet obligations, operate your business smoothly, and take advantage of opportunities that may present themselves.
If you need faster access to working capital than you can produce by realigning your business processes – by being more aggressive about collecting payments, or less enthusiastic about restocking your inventory - you’ll want to look for outside funding. You really don’t want to operate without the right ratio of working capital – over time, a shortage can cause even a profitable business to fail.
Sadly, owners of smaller businesses often struggle to access working capital from bank loans – the application process is complex and demanding, and requirements are strict. You may not have the time, know-how, patience or credit history to qualify for the same financing options that were designed to meet the needs of big businesses.
One Park Financial works to help owners of small and mid-sized businesses access the working capital that they need. Our process is simple and straightforward, and we’ve helped many small businesses who have been turned down by banks to access funding. Visit oneparkfinancial.com or call 855.218.8819 to discover the options that make sense for you and your business.