Business owners often struggle to maintain a proper working capital, which can lead to severe cash crunches. Therefore, before diving into the aspect of how to determine the working capital requirements for a business, it is imperative to have an idea as to what is working capital.
By definition, working capital can be defined as the amount by which the current assets exceed the current liabilities. Essentially, it acts as a measure of a firm’s overall efficiency and is also an indicator of its short-term financial position.
A business would struggle to continue its operations smoothly and would also incur losses if sufficient working capital is not present. Therefore, to maintain profitability, and individual owning a business should harness efficient strategies for working capital management.
Now a majority of the business owners wonder as to how to determine the working capital needs. These needs can be referred to as the amount of money that an organization would require for bridging the gap between the accounts receivable and accounts payable, and they can easily be ascertained by understanding an organization’s working capital requirements.
What are the factors which help determine working capital requirement?
Illustrated below are some factors which help businesses determine working capital needs and, in turn, helps in the working capital calculation:
A substantially high sales volume helps in the generation of significant revenue. This indicates that the working capital needed isn’t much.
- Type of business
Compared to a business related to the manufacturing sector, the trading businesses need a relatively higher working capital.
- Duration of an operating cycle
The more time a business takes to convert the current assets into cash equivalents and cash, the higher would be the working capital need.
- Terms of credit
Those businesses that offer longer credit terms to their customers are more likely to require a higher amount of working capital.
- Seasonal variation
Businesses that depend on particular seasons might require higher working capital.
- Inventory turnover
Slow or stagnant turnover arising from extensive inventories leads to a higher need for working capital.
- Production technology
Businesses that employ machinery require comparatively lesser working capital than those that are labor-intensive in nature.
Ways to compute the working capital needs of a firm
The below-mentioned formula would help an individual in the working capital calculation for their firm:
Working Capital = Current Assets – Current Liabilities
In this above equation, current assets would include the following:
- Cash equivalent
- Company inventory
- Accounts receivable
- Cash in hand
- Pre-paid liabilities
And, current liabilities would consist of:
- Notes payable
- Income tax owed
- Immediate debts
- Accounts payable
A business owner can easily determine how much working capital the business needs using the above-mentioned formula. If it is found, for instance, that a firm’s current assets exceed the current liabilities, this implies that there is surplus working capital with the firm. One must note that factors like non-trade receivables, cash commitments, and wasted or old inventory are adjusted or excluded during the working capital calculation.
How to acquire working capital for a business?
Working capital turns out to be immensely necessary for almost any kind of business as basically it is the amount which companies need to keep their operations afloat. Therefore, when it comes to acquiring funds for continuing business operations, a working capital loan can prove to be a handy option.
A working capital loan is a kind of business loan utilized for a firm’s short-term financial goals to meet operational requirements. However, having mentioned that, one must keep in mind that such a loan might not ensure stability on a long-term basis but would definitely allow the businesses to function in the short term.
Several reputed financial institutions offer working capital loans. However, every borrower acquiring these loans must keep in mind to repay the loan punctually. This would enable them to earn several benefits apart from giving their credit scores a boost.
For instance, financial institutions such as Bajaj Finserv provide pre-approved offers, which help in simplifying and accelerating a lending process. These offers are provided on various financial products like home loans, loans against property, and more. Borrowers can check their pre-approved offer by providing a few details such as name and contact number.
After going through this article, one can easily determine the working capital needs for one’s business and proceed with the working capital calculation using the formula and factors mentioned above.