Why is Working Capital Important?

Managing working capital effectively is crucial to business continuity and growth. By doing so you’re ensuring adequate cash flow is in place for day-to-day operations to continue, covering all of the necessary short-term costs.

Ensuring the appropriate working capital is in place can often be the difference between a business succeeding or failing. 

 

What is Working Capital?

Working capital is sometimes referred to as net working capital (NWC), the two mean the same thing and relate to the cash that your business needs to operate from day to day.

Essentially, it is the money left over after you have accounted for income and expenditure over a set period. Or, to put it another way, it is the total left after subtracting a business’ current liabilities from its current assets.

 

Why is Working Capital Important?

Effectively monitoring and managing your working capital is an essential part of keeping a business afloat. It is not uncommon for companies that appear profitable to cease trading due to being unable to meet short-term financial obligations.

Companies that are growing quickly, in particular, may see their needs for working capital increase rapidly. Common causes include when investing heavily in inventory and stock as accounts receivable will dramatically increase as a result.

 

How to Calculate Working Capital

There is a tried and tested formula for working out exactly how much working capital is needed for any given business.

 

Working capital = current assets – current liabilities

The resulting figure will help you gauge whether the business is able to meet its short-term financial obligations or if there may be issues in doing so. Generally speaking, the bigger the figure, the easier it will be to meet day-to-day costs.

 

Working Capital Ratio

Working out this ratio gives an accurate understanding of how many times your business can pay off its current short-term liabilities using existing assets. The formula is as follows:

 

Working capital ratio = current assets / current liabilities

Any ratio that comes out less than 1 indicates that financial difficulties are highly likely. This is because you do not have the cash necessary to service short term liabilities even once. This can be an issue even for companies with fixed assets like property as liquidating them takes time. 

 

How Much Working Capital Does a Business Need?

The working capital needed by each business depends on a whole host of factors. One crucial one is the overall length of cash flow cycle (the length of time taken to receive payment for goods or services delivered).

Working capital requirements include all costs and outgoings that need to be covered during the waiting period. There also needs to be a safety net in place to account for any unexpected costs that may arise in that time.

You’ll need to cover operational costs for the time it takes to produce your product or deliver your service, during the invoicing period and while waiting for payment. Depending on the nature of your business, this could be quite some time.

The longer your cash flow cycle is the greater level of working capital you need. Having a sound understanding of the timings involved is vital to getting it right.

 

How Much Working Capital Does a Business Need?

The working capital needed by each business depends on a whole host of factors. One crucial one is the overall length of cash flow cycle (the length of time taken to receive payment for goods or services delivered).

Working capital requirements include all costs and outgoings that need to be covered during the waiting period. There also needs to be a safety net in place to account for any unexpected costs that may arise in that time.

You’ll need to cover operational costs for the time it takes to produce your product or deliver your service, during the invoicing period and while waiting for payment. Depending on the nature of your business, this could be quite some time.

The longer your cash flow cycle is the greater level of working capital you need. Having a sound understanding of the timings involved is vital to getting it right.

 

How to Manage Working Capital

Having effective measures in place for managing working capital helps not only cover short term financial obligations but aids growth and boosts overall earnings.

An up to date and accurate cash flow forecast allows you to gain insight into upcoming cash flow cycles and helps you understand the level of working capital you need. 

Ultimately, businesses should aim to reduce their cash flow cycles as much as possible. This helps get capital into the business more efficiently.

 

You can do this in several ways:

1. Reduce Debtor Days  – Shortening the amount of time it takes for customers to pay you
2. Increase Creditor Days – Giving yourself more breathing space when it comes to paying suppliers 
3. Managing Inventory Effectively – Ensure stock is only bought when absolutely needed 
4. Utilise Working Capital Loans – Loans are a great way to smooth out any short term cash-flow problems

 

Working Capital Loans From White Oak UK

Our working capital loans have helped hundreds of businesses manage their short term financial needs and requirements. The loans we provide are specifically tailored to help with short term liquidity issues, smoothing them out so that businesses can focus on what they do best. 

Crucially, our working capital loans are not for funding expansion or investments. For longer-term options, have a look at our range of asset finance solutions.