Updated: 6 days ago
Spend your working capital wisely. This advice should resonate with you, whether you are an established business or a budding entrepreneur. However, you must remember that this accounting term may be the deciding factor to make or break your business. To manage your company's working capital effectively, you need to understand what it is, why it is critical, and how you can utilize it for maximum gains and returns.
What is Working Capital for Businesses?
Working capital is the amount of money you need to manage all short term expenses for your organization. This may include day to day operational expenses, debt payments, inventory maintenance, and replenishment. In short, it’s the daily driver for any business, irrespective of its size. Your working capital has an impact on various aspects of how you run your business, such as paying the workforce and vendors, keeping your doors open for business, and planning sustainable growth in the long-term.
Calculate Your Anticipated Working Capital
It is better to know your business’ financial condition. You can do so by calculating your working capital ratio. The working capital formula is current assets/current liabilities = working capital ratio. For example, if your current assets stand at $2 million, while current liabilities sum up to $10,00,0000. This makes your business’ working capital ratio 2:1, which is considered to be a healthy figure. However, for some business sectors, a lower ratio of 1.2:1 is also adequate. Networking capital gives you an exact figure as to what finances you have available at hand to meet short term expenses. The formula to gauge your networking capital is Current assets – Current liabilities = net working capital.
Know Your Business Financial Needs
You must develop a strategy to know your working capital needs by plotting monthly influx and outflow of finances. Sometimes you may have to forecast numbers but ensure that these financial predictions are based on educated guesses. You can do so by monitoring and evaluating your record of financial numbers. You will need to compare these in addition to any new financial commitments you may engage in as a business, such as new contracts, vendors, hiring, and relative expenses. Once you have a clear picture of what your actual working capital is, you can effectively use your working capital for increased productivity and operations.
10 ways to utilize Your Working Capital:
Bridge Payment Delays: A payment delay is common in the business sector. For example, if you sell something in the market today, there will be a delay in your payment; you may get it after a month or so. In these circumstances, your working capital can bridge the gap and come in handy for primary expenses until you get paid.
Cover Seasonal Expenditures: Whether you are a seasonal industry or expecting a higher forecast in the coming season, hiring temporary staff and restocking before the season starts can be a tricky task. Working capital is your savior in such a situation and can prove useful to cover additional costs.
Enhance Creditworthiness: If you work with lending institutions who share your lending reports with credit check agencies, healthy working capital is good news. It can ensure you never fall behind a payment, which improves your credit score.
Equipment Update: If the need to update your equipment arises or you come across an unexpected good deal on new equipment, what do you do? Of course, it is understandable that you may not have the cash at your disposal straight away. In such scenarios, working capital funding can be very useful to cover the cost of an equipment upgrade.
Growth Opportunities: As a business, you never know when a growth opportunity might present itself. What if you come across an opportunity to buy out a competitor or purchase a location that will help expand your operations? You can utilize a working capital loan opportunity to cover the upfront advance payment.
Human Resource Expenses: One of the best ways to utilize your working capital is to invest in your HR and employees, especially staffing or payroll factoring. You can award hiring bonuses, job fairs, and employee events.
Manage Cash Flow: When you find your business struggling due to a cash flow crunch, you can fall back on working capital to meet expenses such as utilities, mortgages or leases, payroll, and other business-related expenses.
Marketing Campaign: Launching a new marketing campaign is always a good idea to increase your clientele, re-imagine your brand, or invest in a new website. Working capital is the best resource to invest in such activities as they may guarantee increased ROI for your business. Extending favors by event sponsorships and advertisements are some of the ways to effectively invest your working capital finances.
Outsource Expertise: When you talk about marketing campaigns and other related activities, outsourcing experts is your best bet. Always remember; just as you are good at what you do, marketing and advertisement professionals are experts in their respective arenas. You can hire a consultant to implement new management software in your infrastructure. On the other hand, a digital marketing company can design a strategy to give you a competitive edge over competitors. Similarly, a financial advisor can help your business manage finances for greater efficiency.
Restock and Covering Seasonal Shortfalls: You can utilize your working capital to replenish your inventory. It can be helpful to procure new products to sell or restock on current inventory to meet consumer demands in the future. And during the off-season, when sales drop your cash flow, it is a backup to keep you afloat.
Apart from the above ways your business can effectively use working capital loans from companies like Porter Capital, you can use working capital to pay off pending taxes on time. Renovations and expansions are other areas that you can take care of, and of course, there are always unforeseen circumstances that a business may face now and then. Healthy working capital can simply help you deal with out-of-the-blue hassles.