The amount of working capital that you need varies a lot from one business to the next. It depends on the type of business you’re running and the goals that you have for your future growth.
So, if the question is how much capital do you need, there’s really no one-size-fits-all answer. But don’t let that discourage you because we still have a few tips and tricks up our sleeves.
What is working capital?
Working capital is the cash you use daily to make sure your whole operation runs smoothly. In other words,whether or not your current assets are enough to cover current liabilities. It’s also sometimes referred to as operating liquidity, cash flow and current ratio.
You might want to check out this article that goes into the whole concept a little deeper.
What does your working capital say about your business?
Working capital is not just the fuel for your daily operations, it also says a lot about your business. It’s a proverbial chatty Cathy.
A positive working capital says things like, “Hey, your business is doing great, you’ve got more than enough cash to meet your short-term obligations. You’ve got great growth potential, keep it up!”
In contrast, a negative working capital might say, “It looks like there’s room for improvement here. Let’s start looking at the options available to get a much needed cash flow boost into your business!”
A good starting point is to make sure your available funds are high enough to cover any financial obligations you might have. Of course, this isn’t always possible but it’s the goal you should always be striving for.
How much working capital does your business need?
While there may not be a golden rule when it comes to working capital, let’s start with a more general rule of thumb…
If you have very a large business you might be able to get away with letting your working capital slip into the sub zeroes. If on the other hand, you have a smaller business – anything from a start-up to a medium-sized enterprise – you’ll need to keep your working capital position in the positive.
To take a more calculated approach, you can use the working capital ratio – also sometimes referred to as the current ratio…
The ratio works by dividing your business’ total current assets by your total current liabilities. This measures how fast you can meet all your debt requirements if they all came knocking at your door at once.
Your current assets in this scenario are all the assets in your business that you can turn into cash within a year. Your current liabilities are all the short-term and long-term debt and payables that are due within that same period.
Typically, the higher your working capital ratio is, the better your business is doing. It shows that your business is more flexible and can look into investing in its future.
If your ratio is lower than 1:1 you might want to look into why this is happening and set your sights on a ratio of 2:1 as first prize for your business. You may also find it useful to read this article about understanding your working capital cycle.
At MarketFinance, we know that running a business isn’t easy. We’ve been there, we are there, we get it! That’s why we’ve made it our mission to help ambitious business leaders get wherever they want to go. Click here for more information about our quick and easy working capital solutions.