For any company looking to grow, working capital is an important metric to pay close attention to.
If you're wondering how much you could be growing your business this fiscal year, try our working capital calculator to see where you're at and what your target should be.
Below, you'll find everything you need to know about working capital, including how it's calculated and what it means for your business.
Though the math is relatively easy, using a working capital calculator can help you save time, without sacrificing accuracy. Having this great tool at your disposal allows you to focus on what really matters: developing your business.
Over time, the cycle changes, but by managing working capital, businesses can continue to grow and adapt. A working capital calculator can ensure that a company's assets are optimized year round.
Additionally, our algorithm helps you set realistic goals for your working capital based on a few simple details. Try it today.
Working capital is an important aspect of finance.
It considers two elements: a company's assets and its liabilities. It doesn't come into play when you're considering long-term investments like stocks or long-term liabilities, like depreciation.
The figure is a simple calculation of current liabilities subtracted from current assets. Though basic, this equation belies the complexity of the elements it entails.
A working capital calculation shows a company's ability to pay off the liabilities that its responsible for with the assets that it has access to. While there might be $10,000 in bills in March, there should be $30,000 in assets coming in around May.
That's why companies calculate capital over a fiscal year. Calculating day to day can be misleading.
Assets are what a company has access to in economic terms.
If a company owns or controls anything of economic value, that's considered an asset. An asset doesn't have to have an immediate benefit, as in cash, since it could also be inventory, property, or investments that are growing.
It could even include costs that get paid in advance. If there's any prepaid rent or insurance that's bought in advance, this can be an asset.
A company's inventory, land that's owned, buildings, equipment vital to the work that you do, cash, and accounts receivables are all measurable assets.
Basically, any assets a company can liquidate or use within a year are often included in the total value of assets.
Liabilities are the financial inverse of assets and what could become a drain on them. Any financial debt that your company has or obligations that hang over a company's head are liabilities.
Liabilities are the things that a company pays to operate. Accounts payable, salaries, wages, and income taxes are all considered liabilities.
Any costs of maintenance that need to be paid year-in and year-out could be a liability. If money is being allocated for research on a product or project before there's a return, that could be a liability
A company's liabilities are usually items that need to be paid within the coming year.
Calculating a company's working capital ratio is an efficient way to track the health of a business.
Since your amount of working capital will likely vary year to year, taking a current ratio helps to keep the company's growth in perspective.
To understand an overall ratio from year to year, assets are often divided by liabilities.
The ideal number is going to be greater than one. Numbers less than one show that liabilities going out are dragging on the number of assets coming in.
Watch out for numbers over two, however. Since you should be investing the money you're getting into growth or non-liquid investments, you shouldn't be holding on to so much capital.
Non-liquid assets will typically grow faster than capital will sitting in a checking account.
Anyone looking to invest considers a company with a negative working capital figure financially risky. If a company has negative capital, there could be late fees and short-term debt that grows into long-term debt.
Although negative capital can be scary for some businesses, a few models have operated on negative capital. Amazon, Facebook, and even Walmart have operated on negative capital at some point in their career. When assets outsource to suppliers, inventory is in their hands.
This gives the image of having a lower inventory or having fewer assets, but as the capital comes in through their own model, traditional measurements fail. The ability for these companies to thrive depends on outsourcing the "stuff" that people buy to other users of their brand or resources.
You can also measure working capital cycles by the time it takes for money to turn around. A company with a short cycle is an efficient company that makes money fast. The shorter a company's working capital cycle is, the less it delays payment, the faster it can invest in longer-term assets.
There are generally two ways to improve your working capital, by obtaining financing or optimizing your operations.
Loans and lines of credit can offer some help to pay back debt but might only exacerbate issues in the future. Make sure you've calculated your figures accurately before you make any decisions.
The alternative, working on your business strategy, is a better way to improve your working capital. By selling equity, invoices, or arranging trade credit, companies can raise a little more capital to pay off some of their debts.