How to Calculate Working Capital in Your Small Business

As small businesses start to reopen and reestablish after facing months of shutdown due to Covid-19, many will find themselves having to make tough financial decisions. Businesses will have to determine how they’re going to cover bills, pay insurance, take care of salaries, and replenish stock after having months of limited to no income.

Until revenue returns to normal, small businesses will have to pay close attention to their working capital to ensure that they’re able to pay for operational funds. Small financial mistakes during this time could result in businesses struggling to survive. 

As a business, you may find yourself having to lay employees off or limit what stock you have available to take care of the operational budget. If you don’t yet have a good understanding of working capital, now is the time to familiarize yourself with it. 

Working capital: an introduction

The quick definition of working capital is the money you have readily available to fulfill your business operation needs. It is the difference between your current assets and your current liabilities. It’s the money you need to take care of short-term obligations, such as paying your employees and purchasing supplies for your business. 

Working capital is also a way to examine the short-term financial health of your business. Ideally, you want to have positive working capital. Not only does this mean that you have enough money to take care of financial obligations, but it also allows you to start making investments that allow your business to grow. If your liabilities are greater than your assets, you could struggle to grow or could find yourself going bankrupt. 

Determinants of working capital

Many factors might impact the working capital of your business. Your industry will play a large role. For example, a business that focused on manufacturing products may need a larger amount of working capital in comparison to a business focused on social media marketing, since the manufacturing business needs to purchase more supplies. 

The size of your business also matters. You’ll find that larger businesses can generate revenue more quickly, giving their business more of a cushion than a smaller business. Other determinants of working capital include your business cycle, market competition, rates of taxes, the volume of business, and seasonal factors. 

Calculating working capital

Your working capital should be part of your financial modeling spreadsheet. To calculate it, use the following formula: Working capital = Current Assets – Current Liabilities. 

Assets refer to factors such as cash available, inventory, and prepaid expenses. Liabilities refer to factors such as accounts payable, short-term debts, accrued expenses, or monthly payments towards long-term debts. However, once you calculate your working capital, you also have to know how to use that calculation to benefit your business. 

Staying on top of working capital

As a small business, you ideally want to pay off all debts and expenses from each cycle with your revenue. Unfortunately, some businesses struggle with this, depending on the length of their business cycle. And staying on top of working capital might be even harder at the moment due to Covid-19, especially if you’re seeing a decrease in revenue. 

Revisit your business plan. Make sure that your revenue and cash flow are currently up to date. Also, start looking at your projected finances. Now is the time to start thinking about if there are financial cuts you need to make. Or, you may even need to consider taking out a working capital loan.  

Moving forward with a loan

During this time, you may find yourself struggling to pay for operational funds. One option to increase working capital for small business owners is to take out a loan. Working capital loans are designed to provide fast funding to small businesses that need help paying for daily expenses.

Lenders may ask to see your business plan, tax documents, and financial documents, so start gathering your paperwork into one place as soon as possible. Factors that may be taken into consideration when you’re applying to a working capital loan include how long your business has been in operation, what your monthly sales typically look like, and how quickly you think you’ll be able to repay the loan. 

Key takeaways 

Working capital is what you’re going to use to pay off your operational needs. Staying on top of your working capital is always important, but even more so right now, as many small businesses are struggling financially due to Covid-19. If needed, a working capital loan can help your business pay for operational needs.

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Fabrizio VanMarcino

Fabrizio Van Marciano is a self-taught web designer, front-end web developer, and content creator. He is the founder of FVM.