Why Is Working Capital Important?

Why Is Working Capital Important?

Working capital is an accounting term that you will often come across in business. It can influence the success of your business as it affects various aspects of the company, such as paying vendors and employees, paying utility bills, and planning for long-term growth. In simple terms, working capital is the cash available to meet a business’s obligations. To ensure working capital is helping you, you will have to calculate your current levels, estimate your future needs and ensure you always have adequate cash.

Calculating Working Capital

You can get a clear picture of where you stand by calculating your working capital ratio. The formula is as follows:

              Current assets / Current liabilities = Working capital ratio

If your current assets are $2 million and liabilities are $500,000, your working capital ratio is 4:1

Understanding Your Needs

To understand your working capital needs, you will need to analyze the monthly inflows and outflows of your company. For instance, if you are a roofing company, you may find that over spring, you have a revenue spike which can drop to almost zero during winter. However, the business still has expenses that do not depend on seasons and must be met.

When calculating the needs of a business, you can rely on historical results. Note that there will be some difficulties in making accurate projections, especially if the company is growing fast. However, these projections can give you an idea of the period when you have more cash inflow and months when the cash flow gap is wide.

Reasons Your Business May Need Extra Working Capital

All businesses will have periods when they need additional working capital to fund certain expenses such as salaries or vendors. Besides that, seasonal differences can also affect cash flow, necessitating the need for working capital. 

Qualifying for a Working Capital Line of Credit

When you apply for a line of credit, the lender will look at your balance sheet. A balance sheet shows whether a business is healthy. Lenders will also look at your finances, tax returns, credit score, etc., before giving you funding. That is because, for small businesses, their business finances are usually intertwined with personal finances.

Working capital is a huge part of any business. If you are ready for funding through working capital, contact TCF Capital and let us walk you through the application process.