Working Capital Formula 101: All You Need to Know!

If you are thinking about starting a business, you may have heard of working capital. This refers to the resources companies have left when all expenses have been deducted from the assets. You can calculate working capital by using the working capital formula.

Working capital formula 101 from Family Money

Working capital formula 101 from Family Money

What is the Working Capital Formula?

Working capital = current assets – current liabilities

As seen above, the working capital formula involves the current assets and liabilities. But what exactly do these include?

Current assets: These are assets owned by a company at a specific time. The term refers specifically to resources that you can convert into cash within a year. In other words, not all company resources belong in this category. The relevant assets can be divided into five main groups:

  • Cash
  • Inventory
  • Accounts receivable
  • Marketable securities
  • Prepaid expenses

Current liabilities: Any amount of money that a company owes is a business expense. Certain expenses that must be repaid within a year are known as current liabilities. Such expenses can be the following:

  • Short-term loans
  • Accrued expenses
  • Accounts payable
  • Deferred revenue
  • Current part of long-term debt
  • Income tax owed – Read all about business tax.

How Do I Calculate Working Capital?

We can calculate the working capital using the working capital formula. It can also be useful to determine the working capital ratio.

Net Working Capital

In simple terms, working capital is calculated by first adding the current assets and the current liabilities. After that, the liabilities are deducted from the assets. Let us look at an example.

CURRENT ASSETS
CURRENT LIABILITIES
Cash £50,000 Accounts Payable £30,000
Inventories £90,000 Accrued Liabilities £12,000
Accounts Receivable £10,000 Short-term Borrowings £7,000
Total £150,000 Total £49,000
Working Capital = £150,000 – £49,000 = £101,000

Working Capital Ratio

As mentioned, we can also determine the working capital ratio. This is done by simply dividing the assets by the liabilities. For instance, if a company owns assets worth $900,000 and has liabilities of $300,000, then the ratio can be found as follows:

Working Capital Ratio = £900,000 / £300,000 = 3

In this case, the working capital ratio is 3. This is an indication of a strong financial situation. A positive working capital ratio enables businesses to manage their short-time operations with ease. It also facilitates investment in business development.

What is Included in Working Capital?

The working capital is the resources that a company has available after all the expenses have been deducted. The capital can be either money or assets that you can turn into money within a year. This means that you can not count all resources as working capital. For instance, a company may own land or real estate, but due to its location, it may be impossible to sell within twelve months. In this case, it will not count as working capital.

Assets that you can include in working capital are inventories, cash, prepaid expenses, accounts receivable, and marketable securities.

Why is Working Capital Important?

Working capital is important because it tells you a lot about your company’s financial health. It identifies what resources you have available to cover your day-to-day expenses. Likewise, your working capital determines how much money you have available for unexpected events and business development.

Where Can I Get a Working Capital Loan?

First, it is essential to understand the meaning of such a loan. A working capital loan is used to help companies maintain existing operations. In other words, the loan is designed to help businesses with cash-flow.

If you are considering a loan, you can turn to a bank or loan company. There are plenty of lenders who provide this type of support, and it is generally not too difficult to qualify. More often than not, you don’t have to look further than your computer. These days, many moneylenders accept online applications. NOTE: If you do apply for a loan online and get declined, you might find this useful reading – What you should do after your loan was declined.

What are the Pros and Cons of Working Capital Loans?

Like any other loan, working capital loans must be repaid, which means you will not have to provide equity to the lender. Instead, you will keep full ownership of your business and repay the debt as agreed. Another advantage is that many of these loans are unsecured. That means there is no need to provide the bank with collateral.

On the downside, some loans do require collateral. This is especially true for companies with a modest credit score. Working capital loans can also have high-interest rates. To some extent, they depend on your own credit score. The better rating you have, the lower the interest will be for you. For this reason, a less than perfectly managed payment could hurt your personal credit score.

Bottom Line

Every prosperous business understands the importance of working capital. When you know exactly what type of capital you have available, your chances of success increase dramatically. Therefore, we recommend that you continue researching this topic. After all, knowledge is a surefire way of creating your own success story!

FAQ’s

What are a Company’s Short-Term Operation Needs?

A company’s short-term needs are the costs required for day-to-day activities. This includes the payment of wages, debt, and rent. Of course, unexpected expenses may also arise. For this reason, a surplus of capital is essential.

Is Positive Working Capital Always Beneficial?
Every business should aspire to have positive working capital. That allows companies to manage their short-term operations with ease. It also facilitates investment in business development. However, sometimes a surplus of capital can signal certain weaknesses. For instance, it could suggest a lack of investments.
Can Startups Receive Working Capital Loans?
Yes, startups can receive working capital loans. Since the owner’s credit is of significance, a good rating is essential. In case your credit score is modest, you may not qualify. If you do, the interest rate will likely be fairly high. For information on small business loans, go to all you need to know about small business loans.
Should Small Businesses Think About Working Capital?
All companies should consider their working capital. Even if you are self-employed, you have to be in control of your finances. You should know exactly what resources and expenses you have. That way, you will have better opportunities to develop your business successfully.

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