Do you want to measure the financial health and success of your business? Though you can get a fair view of your success through your customer base and profit, however, that’s not enough, there are numerous ways beyond. Along with other indicators, the working capital can let you know about your business standing and what finances it needs to meet its daily expenses.
If you are running a business or willing to start one, you must know what you need to keep it afloat. Therefore, you need to have a good grasp of the working capital formula to rock in the business world. Let’s kick off with what is working capital.
What is Working Capital?
Working capital predicts the health of a business and provides information on funds that are needed to meet its day-to-day financial obligations. This information is necessary for the regular working operations of the business, that includes:
- Payment of salaries
- Reimbursement of suppliers
- Restocking products
- Office/factory maintenance
Looking for a qualified accountant, bookkeeper or tax expert? Get in touch with us right now!
What is Working Capital Formula?
If you want to measure the short term financial health of a business, you need to use the working capital formula. It lets you know whether you have sufficient money to fulfil your financial responsibilities in the short run. To calculate use the following formula:
Working capital = current assets – current liabilities.
Current assets are the cash that you receive from sales. On the other hand, the money you are spending on expenses like IT etc are current liabilities. As your business needs regular cash to meet its day-to-day expenses and unexpected costs.
A poor cash flow can’t cover that cost, which ultimately leads to the failure of a business. Besides, you need a great amount of working capital to face any emergency.
This formula keeps you up to date about your cash flow situation for management accounts. If you have positive working capital, it implies that you can easily pay off your short-term liabilities. Conversely, a negative working capital indicates that you’re not in a condition to meet your debts.
Consequently, it leads to cash flow problems that are the main causes of business bankruptcy, therefore it’s crucial to understand and monitor.
Be worry-free about your business finances by getting in touch with CruseBurke!
How to work out the working capital ratio?
The working capital ratio indicates how frequently your business can pay off its current liabilities by using its current assets. If this ratio is less than one, there are more chances of financial difficulties. You can calculate it by:
Working capital ratio = current assets/current liabilities
Working Capital Requirement
Startups often find it difficult to determine how much working capital they need at the beginning. As it is difficult to identify as it never remains constant and fluctuates regularly.
Many businesses spend costs to provide resources for the production and delivery of their products and services. This happens as suppliers are needed to be paid before the reimbursement by your customers. For instance, the house builder needs materials like blocks, bricks, doors etc to build homes to sell.
This cycle is called the cash flow cycle or operating cycle. You need to bear in your mind that, your funding requirements are dependent on the length of the cash flow cycle. It shows:
- Time for the production and provision of your products or services
- Duration of preparing and sending invoices for products or services
- Time required to get paid by the customers
The working capital is essential to cover this time delay. As the longer the cash flow cycle, the more capital you need. Fo this reason, it’s imperative to put payment collection policies in place to ensure you’re reimbursed by the customers quickly.
Quick Sum Up
So, with the help of the working capital formula, you can better manage your cash flow. But, you need to track it on a weekly or monthly basis to know how and when you need funding to fulfil your business needs. Moreover, you also need to keep track of your quarterly VAT and corporation tax. These will be in separate saving accounts so that you don’t see them as spending money. An accurate and up to date cash flow forecast will let you know what’s happening with your working capital. Finally, with this, you can make better business decisions for its long-term success.
For a customized package, Get an instant quote right away!
Disclaimer: This blog is just for general information on working capital.