There’s often a big gap between the money that goes out and what comes back, especially if you sell overseas. Working capital is important for businesses that export goods and services overseas.
What is the working capital?
Working capital can be a useful tool to assess how well your business is doing. It’s simply the money that you have to cover your financial obligations and operating costs.
Working capital can be calculated by subtracting your current liabilities, such as payroll, loans, and debts, from your existing assets, like cash and accounts receivable.
Net working capital = [Current Assets] – [Current Liabilities]
If your net working capital is positive, you will have enough money to run the business smoothly and even survive a drop in demand or a payment gap.
A working capital ratio is another way to describe working capital. Divide your current assets by current liabilities to calculate it.
Net working capital = [Current Assets] / [Current Liabilities]
The amount of working capital that a business requires will depend on a variety of factors, including the type of business and its operating cycle.
Businesses with physical inventory may need more capital before they see a return from sales. Similar to seasonal businesses like tourism and education, they experience an increase in sales during certain seasons of the year with long periods in between.
Working capital is a safety net that helps businesses get through slow months and until the cash flow starts to pick up. You can use it to seize new opportunities, such as upgrading equipment or increasing production in order to fulfill a new contract or take on a project with long payment terms.