Cash flow and working capital are two crucial metrics that enterprises need to have a hold on to ensure survival. If you are unable to gauge your working capital requirement, it can get exceedingly hard to manage daily operations and make key investment decisions. It can also hamper your company’s revenue and growth prospects significantly.
Working capital or net working capital (NWC) is defined as the difference between an enterprise’s existing assets—including accounts receivable, finished goods, raw materials—and current liabilities like debts, accrued expenses and accounts payable.
Calculating the working capital is important as it provides business owners with a clear view of their company’s short term financial health. Positive working capital would demonstrate that your company can pay its employees, suppliers, debt interests, and other short-term obligations even if there is a cash crunch, whereas negative working capital is a red flag you need to address right away.
In this article, we tell you how you can calculate the working capital requirement for your business.
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The Elements of Working Capital
Before understanding how the working capital requirement is calculated, business owners should have a clear idea of what it entails. Here is a brief view of the various elements of working capital.
These comprise the liquid assets that can be converted to cash within 365 days. This would include:
- Money in the bank account and undeposited cheques received from consumers
- Insurance premiums and other prepaid expenses
- Inventory consisting of finished goods, raw materials, and goods that are still in progress
- Accounts receivable without any consideration of allowances for accounts that are not likely to be paid
- Advance payments on purchases to be made in the future
- The short-term investments that the enterprise wants to sell within a year
- Notes receivable, including the short-term loans to suppliers or customers that will mature within a year
- Receivables like insurance claims, employee cash advance, and income tax refunds
- Money market funds and other marketable securities
The current liabilities include all liabilities that are due within one year, such as:
- Long-term liabilities payable within one year
- Accounts payable
- Taxes payable
- Employee wages
- Interest on loans
- Loan principal that must be paid in a year
- Accrued expenses
- Advance payments for goods and services that are yet to be delivered
Factors that Impact the Working Capital Requirement of your Business
The working capital requirement of your business is affected by a variety of factors like:
- Operating cycle: Enterprises are usually capable of meeting their short-term obligations with the revenue generated from sales. However, a company with a longer operating cycle would require more working capital to meet the costs incurred during the time.
- Type of business: Some enterprises require a relatively higher amount of working capital to survive in the market. For example, retailers, wholesalers, and manufacturers must maintain a large amount of physical inventory, which necessitates more working capital.
- Business goals: A small business looking for a way to expand its operations would require more working capital than an MSME wanting to operate at the same level. Management goals play a major role in determining your enterprise’s working capital requirement.
Steps to Calculate Working Capital
Here is a quick look at the steps involved in calculating the working capital of your enterprise:
Step 1: Calculate all the current assets (CA)
Step 2: Calculate all the current liabilities (CL)
Step 3: Apply the following formula: Working capital = CA - CL
Moving Forward with Kinara Capital
Managing the short-term obligations plays a major role in the long-term success of your enterprise. If you see that your business has negative working capital, it is time for you to take proactive steps to ensure liquidity as early as possible.
Taking a working capital loan can be your best option in such a situation. We at Kinara Capital can help with the quick disbursement of collateral-free working capital loans to ensure that your business stays afloat even during the most challenging times. Our online loan application process is seamless, flexible and requires minimal documentation.
So, take complete control of your working capital with Kinara’s support and witness the exponential growth of your enterprise.
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