Knowing the amount of working capital a company has available is vital to its success. After all, this figure determines how far into the future a company can viably operate into the future. If your working capital is low, you may need to act fast to liquidate assets or take out a loan with a lender.
Assets and Liabilities
The first step in figuring out your working capital is knowing your assets and liabilities. Assets would include the cash you have on hand as well as any outstanding invoices and inventories that can be exchanged for cash.
Your liabilities are your debts, including utilities, taxes, rent, the money you owe vendors, and loan payments. All expenses related to payroll and employees are also liabilities.
Calculating Working Capital
The formula for determining your working capital is simple. Working capital equals your assets minus your liabilities. If your current assets are $20,000, but your liabilities are $10,000, then your working capital is $10,000.
It’s ideal to keep your working capital out of the negative, but you also don’t want too much working capital. If you have too much working capital then you could be missing out on growth or investment opportunities.
To determine the best working capital number for your business, you’ll want to calculate your working capital ratio. To do this, divide your assets by your liabilities. Using the same numbers above, dividing $20,000 by $10,000 gives you a ratio of 2.
A ratio of 2 is a good working capital ratio. Anything below to could signal trouble, while anything above 2 could mean you’re holding on to too much cash.
Part of owning and operating a business is keeping everything in balance. This is why it’s important to track everything that comes in and out of your company.
You can keep a good working balance by following a few good business practices:
- Always negotiate the best payment terms from suppliers.
- Make payment terms clear to buyers.
- Keep inventory in balance, which means don’t overstock or understock.
- Make payments on time to avoid paying interest.
- Make it a habit to regularly calculate your working capital as well as your ratio.
- Make adjustments based on your ratio.
These calculations are simple tricks that accountants use daily. Using them regularly will help you make smart business decisions as well as allow you to better manage how you spend. In time, calculating capital will become second nature.