Do the Math: The Working Capital Formula
Do you know how much working capital your business has? In order to keep your business flexible enough to handle day-to-day expenses, you need to understand this helpful formula. Discover how this formula can help you keep track of your liquid assets, make short-term decisions and save for future expenses simply and effectively.
Although there are many factors that influence your available capital, understanding the working amount of capital you have can be done with a simple calculation. Simply add all your current on-hand assets and subtract the liabilities or expenses you have. This leaves you with your working capital.
Your current assets can include a range of items. It starts with your current cash and bank account balance, but can also include invoices, securities and other liquid investment finances. In other words, your current assets are the total amount of spending power you can use quickly.
Liabilities are typically the combination of every outstanding debt, interest and amount of short-term loans. These are typically defined as any known expense in the next year. All your liabilities will drain the amount of assets that can be used in the formula to generate a working amount.
If you have more liabilities than assets, you have a negative working capital. Obviously, it’s advantageous to your business to keep a positive amount of capital ready at any time. A negative balance doesn’t necessarily mean your company is struggling or too far in debt, but it does mean that your company isn’t very flexible when it comes to sudden expenses or unforeseen investment opportunities. In order to respond promptly to the ebb and flow of your business, it’s almost always beneficial to keep a large sum of capital ready at any moment.
However, some businesses work well with a more fixed-asset model. If your business is in the food service or grocery industries, you won’t need as much flexible capital on hand. These industries often experience a high turnover rate for their inventory. If your business is primarily based in one of these industries, or any other with a high inventory turnover rate, you can enjoy working with slightly less capital than other companies with slower turnover rates.
In order to keep up with the rapid changes in today’s marketplace, keep your company fast and flexible with an adequate amount of working capital. The exact amount depends on your particular industry and business model, so determine for yourself how much capital is necessary to respond quickly to any crisis or opportunity.