No two businesses are created equal. This is one of the reasons why every business’s working capital needs vary, too.
So, if your question is how much capital do I need to run a business, then you should know that there is no one-size-fits-all answer. The type of business you are running, its operating cycle and your goals for future growth have a huge impact on how much capital you may need.
But, that doesn’t mean you cannot obtain an estimate. In this blog, we will share a list of a few tricks and tips to help you handle and manage your working capital effectively.
What is a Working Capital?
Working capital is a cash amount businesses use to ensure their daily operations are running smoothly. It is also referred to as a difference between a company’s liabilities and current assets.
Current assets are anything a business owns and can be converted into cash within a year. The current liabilities, on the other hand, are costs and expenses that businesses sustain within the same period.
Prime examples of current assets are savings accounts, marketable securities, stocks, bonds, etc. Current liabilities include material and supply costs required to purchase goods, make payments on short-term debt, utilities, rent, etc.
When a business has more current liabilities than the working capital, then it means its working capital is negative, meaning the business may find it challenging to meet its financial obligations. When the situation is the other way around, it means the business has ample working capital left after taking care of important operations.
How do various factors impact your business’s capital needs?
1- Business type
Compared to some businesses, certain types of business may require higher working capital. For instance, a business that has physical inventory often require significant amounts of working capital to run smoothly. This includes wholesale business, retail business and manufacturers.
Retailers and wholesalers require purchasing premade inventory for further sales and distribution, whereas manufacturers are required to continuously purchase raw materials to produce inventory.
2- Operating cycle
Typically, most businesses are capable of paying their short-term debts with revenues generated from sales. But, the length of the company’s operating cycle can result in otherwise.
For instance, a business that takes a long time to manufacture and sell products require more working capital to make sure the financial obligations are met.
Similarly, businesses that bills customers for services already provided instead of asking for an upfront payment may need higher capital if the collection in accounts receivables aren’t made in a timely manner.
3- Management goals
Every business owner has specific goals related to business growth and expansion.
A relatively small business looking forward to expanding will require higher levels of working capital in comparison to that small business that intends to stay small. This is particularly true for businesses that are planning to expand their product lines into new markets because the costs of design, development and market research can be high.
Here is how you can find the estimation of your capital requirements
Although there are various golden rules, let’s start with comprehending a more general rule of thumb.
As an owner of a very large business, you will be able to get away with letting the working capital slip into the sub-zeroes. But, if you own a smaller business, then you will need to keep the position of your working capital positive.
To make a more calculated decision, you can utilize the Working Capital Ratio, also referred to as the current ratio.
The higher your working capital ratio is, the better your business is doing in terms of financial aspects. A higher ratio shows that your business is flexible enough to invest in its future.
If your ratio is lower than 1:1, then you might want to check what is happening and create the goal of taking the ratio to 2:1.
Signing off
Capital plays a key role in business operations, irrespective of the industry. But it is evident from the blog that the needs of every business are unique, meaning the requirement of working capital can vary significantly from business to business.
So, work with reliable financial experts to receive a definitive working capital financing solution.