Working capital is the amount of money your company has to pay for its regular day-to-day expenses. It includes your operating expenses, such as payroll, and your fixed expenses, e.g., rent. Your short-term expenses should all be paid with this capital, but there are several things you should know about this money.
Calculation of Working Capital
Your net capital is calculated by subtracting the current liabilities on your balance sheet from the current assets. Current assets are all those that can be quickly converted to cash. Current liabilities are the short-term debts you need to make in addition to your operating costs. This net capital reveals your company’s liquidity, which suggests whether or not you can continue running your business and paying your short-term bills.
Gross capital is all your current assets. It does not consider your liabilities in any way, so it can be deceiving to use this figure in your budgeting process.
Increasing Your Capital
If you find yourself short of capital, you can follow several strategies to increase it. First, you can focus on your collection process. If you have outstanding accounts receivable, you should make an effort to collect them quickly. Although this figure is an asset on your balance sheet, it doesn’t do your company any good if the cash never hits your bank account. Your ultimate goal should be to have a slim capital cycle.
You can also provide incentives to your customers for early payment. Also, invest in making customer payments easy by accepting major credit cards or other preferred payment methods. Keep your invoices up to date and correct any mistakes immediately. You may also ask for a deposit on large projects that covers at least half of the production costs.
You can also apply for small business loans to temporarily cover your shortages. Factoring or invoice financing can also help you get products out the door to customers. For example, if you are working on a project and you don’t have the money to complete it, a factoring or finance company can front you the money by purchasing or using the invoice as collateral. However, watch for hidden fees.
Why You Need Capital
This capital is important when your business is low on cash or your cash flow slows. This can be common in seasonal businesses. You also may need to use this type of capital during growth periods and when you have large projects.
Effective working capital management is vital to your business’s success. Therefore, consider learning more about this asset.