Grow your business by understanding your working capital ratio

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How to find working capital

Running an efficient and sustainable business means being on top of your day-to-day finances. It also means understanding the working capital available. This includes your company’s liquidity, efficiency and short-term financial health. But as a business owner, knowing how to find working capital is important, especially if you need to grow your business.

But first, what is your company’s working capital ratio and how do you calculate it?

What is working capital?

Working capital, also known as net working capital, is the ratio of current assets to current liabilities. The resulting quotient is typically used to determine your company’s ability to meet its short-term financial commitments.

There are many factors included in the two components of working capital. Your current resources include the following:

  • All possessions, tangible and intangible
  • Bank account
  • Actions
  • Credits
  • Inventories

These assets can be quickly converted into cash within a year or business cycle. This means that long-term investments such as real estate or hedge funds are excluded.

Current liabilities, on the other hand, include all expenditure expected within the year or economic cycle. This is when the typical expenses come in. These charges include the following:

  • Rent
  • Supplies
  • Utility
  • Accounts payable
  • Income taxes accrued

Long-term debt and capital leases are included in the calculation. Typically, these debts and leases are due within the year.

How to calculate working capital

Calculation of working capital it’s pretty straightforward, as the formula is simple:

Current Report = Current Assets Current liabilities

Getting a ratio higher than one (1) generally means your assets exceed your liabilities. If you are planning to expand your business, we recommend aiming for a ratio greater than 1.

We illustrate this formula with an example. A global company has a total of $37 billion in current assets for the fiscal year ended December 31, 2018. These include cash and cash equivalents, inventories, short-term investments and accounts receivable. During the same period, this company accrued $26 billion in current liabilities. These include accounts payable, accrued expenses, income taxes accrued, and long-term debt maturing.

Using the above formula, the company has a current ratio of 1.42 in working capital. This means that this company has the wherewithal to finance its day-to-day operations. They can also pay off their debt obligations.

Why you should aim for a working capital ratio above 1

As mentioned above, you’ll want to aim for a ratio above 1 if you want to continue with your business. Having a ratio of less than 1 puts your business at risk among lenders and investors. They consider that having a low ratio or negative working capital means your business may not be able to pay and cover all of its current debt.

Keeping your working capital above 1 means understanding how some current assets and liabilities can change. These changes can occur within a 12-month period. For example, working capital such as accounts receivable or inventory could lose value. Long-term liabilities may soon become a current liability. This can happen when your repayment deadline is just around the corner. Some credits may even be canceled at some point. That would definitely result in another loss.

Because having a working capital ratio above 2 is not good

Having too much working capital is also not a good thing. In general, anything above two (2) can also discourage investors and lenders. Show that your business is letting excess assets sit idle and immobile. If your working capital is on the verge of exceeding the ratio of 2, now is the best time to consider expanding your business. This could come in the form of a new position or a new product or service offering.

What to do with a negative working capital ratio

What if your company works with negative working capital? Is there a way to change things? This is when you’ll need to make a couple of changes, particularly in how you spend your money on your business.

For one thing, you can always reduce your day-to-day expenses by looking for cheaper equipment or negotiating with other sellers. If the problem lies with your receivables, try encouraging timely payments from your customers. You can also research current tax opportunities in your state to make sure your business is in the best position.

How to find working capital

You can work with Loan builder to help you find working capital loans for your business. Get help from financing experts who offer unbiased reviews for working capital loans for small business owners. If you need help growing your business and are looking for working capital loans, you can take our working capital quiz here. After that, we will contact you with our recommendations.

Check out our favorite market lenders.
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This article was published by: Stephanie Stafford by title: Grow your business by understanding your working capital ratio

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