Working capital is an important metric in businesses of all sizes. It tells you where your business stands when it comes to meeting current and short-term expenses. In other words, this metric helps you gauge the current health of your business.
To keep their businesses running smoothly, small business owners need to keep tabs on their working capital. Little working capital makes you struggle to fund daily operational expenses. It can result in interruptions in business operations. Many small businesses use financing to ride out such short-term bumps in working capital to avoid insolvency.
There are many different ways to fund your working capital such as invoice factoring and business lines of credit, but your best bet is to get a low-priced working capital loan from an online lender like Camino Financial.
Excess working capital may mean that you aren’t making wise short-term investment decisions. When money is lying idle, it isn’t helping your business grow! Right?
Use this article to learn what working capital is and why efficient working capital management is vital. We’ll also tell you how a working capital loan can help you meet everyday cash flow needs and keep your business running smoothly.
What is working capital?
Working capital(WC) is the money you need to finance your business’s daily operations. To arrive at your business’s working capital, subtract current liabilities or debts from current assets.
Working capital = Current Assets – Current Liabilities
Current assets consist of liquid assets that you expect to convert to cash within a year. They include inventory, accounts receivable, short-term investments, and cash at hand or bank.
Current liabilities consist of any outstanding debts and other financial obligations that should be met in under a year. They include accounts payable, long-term debts that should be paid down within a year, and any other short-term debts you may have.
As a measure of liquidity, WC helps establish how much cash flow you have or how much you need to finance your business’s short-term financial obligations.
You have enough working capital if your current assets exceed your current liabilities. It means that your business is liquid enough, and there is enough cash flow to cover short-term expenses like payroll, inventory, loans, rent, electricity, among others.
If your current liabilities exceed your current assets, there is a problem. Your business is illiquid in the short term, and you won’t be able to finance daily operations. It results in disruptions in business operations, and in the worst-case scenario, it may lead to asset liquidation and bankruptcy.
What should you do when faced with negative cash flow? A working capital loan is handy in such situations to help small businesses navigate short-term working capital crunches.
Why it’s important to keep an eye out on your working capital
Understanding the ins and outs of working capital is essential in establishing the short-term and long-term health of your business.
In financial terms, this is called working capital management. It helps you understand and meet the current financial obligations of your business while making sure that your business is well-positioned for current and future growth.
The most important metric used to watch a business’s working capital is the working capital ratio. It tells you where your working capital needs to be. Simply divide current assets by current liabilities or debts to arrive at the working capital ratio.
Working capital ratio = current assets/current debts
Per industry standards and working capital best practices, you should maintain a working capital ratio of between 1.2 and 2 to nail your business finances. It means that there is a good balance of liquidity and cash flow in your business. You are keeping enough cash on hand to cover short-term obligations, while proactively investing excess cash for future growth.
A working capital ratio below 1.0 means that your business is unable to fund its operating expenses and other short-term debts. It’s a clear sign that your business is experiencing cash flow gaps. A working capital loan can help you sail through such liquidity issues as you wait for your accounts receivable to top up.
A working capital ratio higher than 2.0, means that you are not taking advantage of opportunities to maximize profits, increase revenue, and continue growing your business. Money that should be invested back into the business for future growth is just lying idle somewhere.
Here are the top benefits of efficient working capital management
Maintain your business’s reputation and goodwill
Sufficient working capital ensures smooth business operations. You won’t run out of cash to meet your short-term financial responsibilities. You can pay rent, loans, workers, and suppliers on time. Creditors, suppliers, workers, and customers end up loving your business culture. That’s how you maintain the reputation and the goodwill of your small business, which is vital for long-term success.
Invest wisely and earn more profits
Working capital management helps you know when you have too much cash flow than you need in the short term. Once you set aside sufficient working capital, extra funds should be put in short-term investments that will create long-term value in your business, position it for future growth, and make it more profitable.
Take advantage of supplier discounts and sudden spike in sales
Sometimes, sales pick up suddenly, and you need to ramp up quickly. These are good times to take advantage of supplier discounts. With enough cash at hand, you can buy in bulk and qualify for discounts from your suppliers.
But a spike in sales may get you off guard in a cash crunch. The best solution is to get a working capital loan at favorable terms from an online lender to purchase inventory in bulk and take advantage of supplier discounts. The alternative is to lose such a valuable opportunity, which simply means leaving money on the table.
Know when you need a quick cash injection
As a small business owner, you mostly rely on accounts receivable to keep your business afloat. Delayed payments may make your business experience a cash flow gap and suffer a working capital crunch. At such times, a working capital loan can help you ride out short-term cash flow gaps.
What are working capital loans and why are they great?
A working capital loan is a kind of business loan advanced by lenders to small businesses to help them survive short-term cash flow gaps and avoid a working capital crunch.
Working capital loans are very helpful because they help businesses boost their working capital and avoid downtimes in their finances. You can use working capital loans to buy inventory if demand peaks suddenly, pay taxes without depleting cash on hand, or just cover any sudden expense that may arise in everyday business operations.
Working Capital Summary
Efficient working capital management is vital to keep your daily business operations running smoothly, while still making wise investments for future growth. From time to time, you may experience short-term cash flow gaps in your business, which can result in a working capital crunch.
At such times, a working capital loan from Camino Financial can help you avoid financial downtimes in your business and keep operations a float.