Last Updated: September 30, 2022
What is Working Capital?
Put simply, a business’s amount of working capital is its level of net liquidity in the short term – typically over the course of the next year. In other words, if you add up all of your company’s money (free cash flow) and anything that can become money very quickly – its cash, raw materials, accounts receivable, and any inventory that can quickly be sold – and subtract all of your current financial obligations, you have found your net working capital. Net working capital is a simple way of judging your business’s short-term financial health.
Small business owners can use this working capital calculator to find out their company’s current level of working capital. Simply plug in the necessary information about a company’s total current assets, and current liabilities, and find out if the business is currently covering its working capital needs.
Working Capital Needs Calculator
Working Capital Ratio
One simple way to analyze your company’s working capital is by looking at its working capital ratio, or its current ratio. Instead of subtracting your current liabilities from your assets, you instead set them up as a fraction. The assets are the numerator, and the liabilities go in the denominator. That allows you to look at working capital as a relative measure, not just in sum.
If your company has $250,000 in current assets, cash, and inventory and $180,000 in liabilities, your current ratio is 250,000 divided by 180,000, or 1.39. In general, you want your working capital ratio to approach 2, as that shows any potential lenders that you’ve got plenty of ability to cover any additional short-term liabilities.
Net Working Capital vs. Current Ratio
Which is a more type of business metric? In truth, both metrics tell the story of a business’s cash flow and can be used in tandem to get a fuller picture.
For example, say Company A has $100,000 in current assets and $50,000 in current liabilities. Its current ratio is 100,000 divided by 50,000 or 2.0, while its net working capital is 100,000 – 50,000, or 50,000.
On the other hand, Company B has $400,000 in current assets and $300,000 in current assets. Its working capital ratio is 400,000 divided by 300,000, or 1.3, and its net working capital is $400,000 – $300,000, or $100,000.
Company A has less working capital overall, but a much better current ratio. For lenders or investors, that could indicate that Company A could be in a good position for long-term lending, while Company B has the immediate resources to pay off short-term debt.
Too Little Working Capital
Without low or even negative working capital, your company will be financially stressed when it comes to covering basic operating expenses. Without enough working capital on hand, business owners might struggle to pay employees, purchase inventory, or make payments on existing business loans. In short, if your assets and cash can’t cover your short-term obligations, it can hamstring your small business’s operations ability and could even lead to adding on additional debt in order to make ends meet. That’s a situation where taking out short-term loans, a line of credit, or another form of business financing might be a good idea to retain some flexibility while paying for your day-to-day operations.
Too Much Working Capital
On the other hand, if you’ve got assets or cash well beyond your business’s working capital requirements, you are likely leaving opportunities on the table. You may have too much inventory on hand, or perhaps your cash is simply not being used to grow your business. Money can’t help you expand if it’s just sitting in your business bank account collecting dust. If you’ve got enough cash, it might be wiser to reinvest that excess back into the company. That spare capital can be used on marketing, expansion, paying down your old startup loans early, or otherwise building your business credit score.
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